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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2004
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission File Number 1-8864
USG CORPORATION
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(Exact name of registrant as specified in its charter)
Delaware 36-3329400
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
125 South Franklin Street, Chicago, Illinois 60606-4678
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(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code (312) 606-4000
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
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Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes X No
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Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 12, 13, or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. Yes X No
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As of June 30, 2004, 43,015,424 shares of USG common stock were outstanding.
TABLE OF CONTENTS
Page
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PART I FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Statements of Earnings:
Three Months and Six Months
Ended June 30, 2004 and 2003 3
Consolidated Balance Sheets:
As of June 30, 2004 and December 31, 2003 4
Consolidated Statements of Cash Flows:
Six Months Ended June 30, 2004 and 2003 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Results
of Operations and Financial Condition 38
Item 4. Controls and Procedures 50
Report of Independent Registered Public Accounting Firm 51
PART II OTHER INFORMATION
Item 1. Legal Proceedings 53
Item 2. Changes in Securities, Use of Proceeds and/or Issuer
Purchases of Equity Securities 53
Item 4. Submission of Matters to a Vote of Security Holders 54
Item 6. Exhibits and Reports on Form 8-K 55
Signatures 56
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PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
USG CORPORATION
CONSOLIDATED STATEMENTS OF EARNINGS
(DOLLARS IN MILLIONS EXCEPT PER-SHARE DATA)
(UNAUDITED)
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
----------------------------- -----------------------------
2004 2003 2004 2003
------------ ------------ ------------ ------------
Net sales $ 1,145 $ 914 $ 2,165 $ 1,776
Cost of products sold 929 780 1,778 1,525
Selling and administrative expenses 79 81 156 161
Chapter 11 reorganization expenses 4 3 6 5
------------ ------------ ------------ ------------
Operating profit 133 50 225 85
Interest expense 1 2 2 3
Interest income (1) (1) (2) (2)
Other income, net 1 (5) 3 (5)
------------ ------------ ------------ ------------
Earnings before income taxes and
cumulative effect of accounting
change 132 54 222 89
Income taxes 52 23 85 36
------------ ------------ ------------ ------------
Earnings before cumulative effect
of accounting change 80 31 137 53
------------ ------------ ------------ ------------
Cumulative effect of accounting
change, net of tax - - - (16)
------------ ------------ ------------ ------------
Net earnings 80 31 137 37
============ ============ ============ ============
EARNINGS PER COMMON SHARE:
Basic and diluted before
cumulative effect of accounting
change 1.86 0.73 3.18 1.24
Cumulative effect of accounting
change - - - (0.37)
------------ ------------ ------------ ------------
Basic and diluted 1.86 0.73 3.18 0.86
============ ============ ============ ============
Dividends paid per common share - - - -
Average common shares 43,017,068 43,045,854 43,020,344 43,097,190
Average diluted common shares 43,017,971 43,045,854 43,021,448 43,097,190
See accompanying Notes to Consolidated Financial Statements.
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USG CORPORATION
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN MILLIONS)
(UNAUDITED)
AS OF AS OF
JUNE 30, DECEMBER 31,
2004 2003
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ASSETS
Current Assets:
Cash and cash equivalents $ 664 $ 700
Short-term marketable securities 65 64
Restricted cash 33 7
Receivables (net of reserves - $15 and $15) 488 321
Inventories 357 280
Income taxes receivable 24 26
Deferred income taxes 44 43
Other current assets 56 57
-------- --------
Total current assets 1,731 1,498
Long-term marketable securities 211 176
Property, plant and equipment (net of accumulated
depreciation and depletion - $862 and $816) 1,800 1,818
Deferred income taxes 148 178
Goodwill 41 39
Other assets 103 90
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Total Assets 4,034 3,799
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable 274 202
Accrued expenses 203 206
Current portion of long-term debt 1 1
Income taxes payable 27 5
-------- --------
Total current liabilities 505 414
Long-term debt 1 1
Deferred income taxes 23 23
Other liabilities 442 429
Liabilities subject to compromise 2,240 2,243
Commitments and contingencies
Stockholders' Equity:
Preferred stock - -
Common stock 5 5
Treasury stock (258) (258)
Capital received in excess of par value 414 414
Accumulated other comprehensive income (loss) (4) (1)
Retained earnings 666 529
-------- --------
Total stockholders' equity 823 689
-------- --------
Total Liabilities and Stockholders' Equity 4,034 3,799
======== ========
See accompanying Notes to Consolidated Financial Statements.
-4-
USG CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN MILLIONS)
(UNAUDITED)
SIX MONTHS
ENDED JUNE 30,
---------------
2004 2003
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OPERATING ACTIVITIES:
Net earnings $ 137 $ 37
Adjustments to reconcile net earnings to net cash:
Cumulative effect of accounting change - 16
Depreciation, depletion and amortization 55 52
Deferred income taxes 25 18
(Gain) loss on asset dispositions (1) -
(Increase) decrease in working capital:
Receivables (167) (85)
Income taxes receivable 2 3
Inventories (77) (17)
Payables 94 32
Accrued expenses (3) (55)
(Increase) decrease in other assets (6) (12)
Increase (decrease) in other liabilities 12 5
Change in asbestos receivable 11 19
Decrease in liabilities subject to compromise (3) (17)
Other, net (8) -
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Net cash provided by (used for) operating activities 71 (4)
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INVESTING ACTIVITIES:
Capital expenditures (47) (36)
Purchases of marketable securities (171) (148)
Sales or maturities of marketable securities 135 91
Net proceeds from asset dispositions 6 -
Acquisition of business (4) (2)
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Net cash used for investing activities (81) (95)
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FINANCING ACTIVITIES:
Deposit of restricted cash (26) (21)
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Net cash used for financing activities (26) (21)
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Net decrease in cash and cash equivalents (36) (120)
Cash and cash equivalents at beginning of period 700 649
----- -----
Cash and cash equivalents at end of period 664 529
===== =====
SUPPLEMENTAL CASH FLOW DISCLOSURES:
Interest paid 1 1
Income taxes paid, net 32 9
See accompanying Notes to Consolidated Financial Statements.
-5-
USG CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(1) PREPARATION OF FINANCIAL STATEMENTS
The accompanying unaudited consolidated financial statements of USG
Corporation ("the Corporation") have been prepared in accordance with
applicable United States Securities and Exchange Commission guidelines
pertaining to interim financial information. The preparation of financial
statements in conformity with accounting principles generally accepted in
the United States of America requires management to make estimates and
assumptions that affect the reported amounts of assets, liabilities,
revenues and expenses. Actual results could differ from those estimates.
In the opinion of management, the financial statements reflect all
adjustments, which are of a normal recurring nature, necessary for a fair
presentation of the Corporation's financial results for the interim
periods. These financial statements and notes are to be read in
conjunction with the financial statements and notes included in the
Corporation's 2003 Annual Report on Form 10-K which was filed on February
24, 2004.
(2) VOLUNTARY REORGANIZATION UNDER CHAPTER 11
On June 25, 2001 (the "Petition Date"), the Corporation and the 10 United
States subsidiaries listed below (collectively, the "Debtors") filed
voluntary petitions for reorganization (the "Filing") under chapter 11 of
the United States Bankruptcy Code (the "Bankruptcy Code") in the United
States Bankruptcy Court for the District of Delaware (the "Bankruptcy
Court"). This action was taken to resolve asbestos claims in a fair and
equitable manner, to protect the long-term value of the Debtors'
businesses, and to maintain the Debtors' leadership positions in their
markets.
The chapter 11 cases of the Debtors (collectively, the "Chapter 11 Cases")
are being jointly administered as In re: USG Corporation et al. (Case No.
01-2094). The Chapter 11 Cases do not include any of the Corporation's
non-U.S. subsidiaries. The following subsidiaries filed chapter 11
petitions: United States Gypsum Company ("U.S. Gypsum"); USG Interiors,
Inc. ("USG Interiors"); USG Interiors International, Inc.; L&W Supply
Corporation ("L&W Supply"); Beadex Manufacturing, LLC; B-R Pipeline
Company; La Mirada Products Co., Inc.; Stocking Specialists, Inc.; USG
Industries, Inc.; and USG Pipeline Company.
The background of asbestos litigation, developments in the Corporation's
reorganization proceeding and estimated cost are discussed in Note 13.
Litigation.
-6-
CONSEQUENCES OF THE FILING
As a consequence of the Filing, all asbestos lawsuits and other lawsuits
pending against the Debtors as of the Petition Date are stayed, and no
party may take any action to pursue or collect pre-petition claims except
pursuant to an order of the Bankruptcy Court. Since the Filing, the
Debtors have ceased making both cash payments and accruals with respect to
asbestos lawsuits, including cash payments and accruals pursuant to
settlements of asbestos lawsuits. The Debtors are operating their
businesses without interruption as debtors-in-possession subject to the
provisions of the Bankruptcy Code, and vendors are being paid for goods
furnished and services provided after the Filing.
The Debtors' Chapter 11 Cases are currently assigned to Judge Judith K.
Fitzgerald, a bankruptcy court judge sitting in the United States
Bankruptcy Court for the District of Delaware. Three creditors'
committees, one representing asbestos personal injury claimants, another
representing asbestos property damage claimants, and a third representing
unsecured creditors, were appointed as official committees in the Chapter
11 Cases. The Bankruptcy Court also appointed Dean M. Trafelet as the
legal representative for future asbestos claimants in the Debtors'
bankruptcy proceeding. Mr. Trafelet was formerly a judge of the Circuit
Court of Cook County, Illinois. The appointed committees, together with
Mr. Trafelet, will play significant roles in the Chapter 11 Cases and
resolution of the terms of any plan of reorganization.
The Debtors intend to address their liability for all present and future
asbestos claims, as well as all other pre-petition claims, in a plan or
plans of reorganization approved by the Bankruptcy Court. The Debtors
currently have the exclusive right to file a plan of reorganization until
December 1, 2004. The Debtors may seek one or more additional extensions
of the exclusivity period depending upon developments in the Chapter 11
Cases.
The plan of reorganization ultimately approved by the Bankruptcy Court in
the Chapter 11 Cases may include one or more independently administered
trusts under Section 524(g) of the Bankruptcy Code, which may be funded by
the Debtors to allow payment of present and future asbestos personal
injury claims and demands. Under the Bankruptcy Code, a plan of
reorganization creating a Section 524(g) trust may be confirmed only if
75% of the asbestos claimants who vote on the plan approve the plan. A
plan of reorganization, including a plan creating a Section 524(g) trust,
may be confirmed without the consent of non-asbestos creditors and equity
security holders if certain requirements of the Bankruptcy Code are met.
The Debtors also expect that the plan of reorganization will address the
Debtors' liability for asbestos property damage claims, whether by
including those liabilities in a Section 524(g) trust or by other means.
If the confirmed plan of reorganization includes the creation and funding
of a Section 524(g) trust, the Bankruptcy Court will issue a permanent
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injunction barring the assertion of present and future asbestos claims
against the Debtors, their successors, and their affiliates, and
channeling those claims to the trust for payment in whole or in part.
Similar plans of reorganization containing Section 524(g) trusts have been
confirmed in the chapter 11 cases of other companies with asbestos
liabilities, but there is no guarantee that the Bankruptcy Court in the
Debtors' Chapter 11 Cases will approve creation of a Section 524(g) trust
or issue a permanent injunction channeling to the trust all asbestos
claims against the Debtors and/or their successors and affiliates. In
addition, if federal legislation addressing asbestos personal injury
claims is passed, which is extremely unpredictable at this time, such
legislation may affect the amount that will be required to resolve the
Debtors' asbestos personal injury liability in the Chapter 11 Cases and
may affect whether the Debtors establish a trust under Section 524(g). See
Potential Federal Legislation Regarding Asbestos Personal Injury Claims,
below.
A key factor in determining the recovery of pre-petition creditors and
stockholders under any plan of reorganization is the amount that must be
provided in the plan to resolve the Debtors' liability for present and
future asbestos claims. Counsel for the Official Committee of Asbestos
Personal Injury Claimants and counsel for the legal representative for
future asbestos personal injury claimants have stated that the Debtors'
liabilities for present and future asbestos claims exceed the value of the
Debtors' assets and that the Debtors are insolvent. The Debtors have
stated that they believe they are solvent if their asbestos liabilities
are fairly and appropriately valued.
The Debtors' asbestos liabilities to be funded under a plan of
reorganization have not yet been determined and are subject to substantial
dispute and uncertainty. While it is the Debtors' intention to seek a full
recovery for their creditors, it is not possible to predict the amount
that will have to be provided in the plan of reorganization to resolve
present and future asbestos claims, how the plan of reorganization will
treat other pre-petition claims, whether there will be sufficient assets
to satisfy the Debtors' pre-petition liabilities, and what impact any plan
may have on the value of the shares of the Corporation's common stock and
other outstanding securities. The payment rights and other entitlements of
pre-petition creditors and the Corporation's shareholders may be
substantially altered by any plan of reorganization confirmed in the
Chapter 11 Cases. Pre-petition creditors may receive under the plan of
reorganization less than 100% of the face value of their claims, the
pre-petition creditors of some Debtors may be treated differently from the
pre-petition creditors of other Debtors, and the interests of the
Corporation's stockholders are likely to be substantially diluted or
cancelled in whole or in part. There can be no assurance as to the value
of any distributions that might be made under any plan of reorganization
with respect to such pre-petition claims, equity interests, or other
outstanding securities.
-8-
It is also not possible to predict how the plan of reorganization will
treat intercompany indebtedness, licenses, transfers of goods and
services, and other intercompany arrangements, transactions and
relationships that were entered into before the Petition Date. These
arrangements, transactions and relationships may be challenged by various
parties in the Chapter 11 Cases, and the outcome of those challenges, if
any, may have an impact on the treatment of various claims under any plan
of reorganization.
In connection with the Filing, the Corporation implemented a Bankruptcy
Court-approved key employee retention plan that commenced on July 1, 2001,
and continued until June 30, 2004. Under the plan, participants received
semi-annual payments that began in January 2002. Expenses associated with
this plan amounted to $2.6 million and $5.3 million in the second quarter
and first six months of 2004, respectively. For the comparable 2003
periods, expenses totaled $5.5 million and $11.1 million. The lower level
of expense in 2004 reflected a provision of the plan that required the
recording in earlier periods of deferred amounts included in the final
payment.
The key employee retention plan, in an amended form, has been extended
until December 31, 2005. The amendments introduce a performance feature
for the last two (of four) payments to be made under the extended plan.
The cost of the extended plan is projected to be approximately $9.8
million during the second half of 2004 and $19.6 million for the full year
2005 before taking into account the performance feature which could add up
to 25% to the final two payments or eliminate them altogether. Because of
the performance feature, expense in 2005 could range from a low of
approximately $7.0 million (assuming failure to meet the performance
target which would result in the final two payments being eliminated) to a
maximum of approximately $22.7 million (assuming full attainment of the
performance target).
POTENTIAL FEDERAL LEGISLATION REGARDING ASBESTOS PERSONAL INJURY CLAIMS
The Corporation has for many years actively supported proposals for
federal legislation addressing asbestos personal injury claims. On April
7, 2004, the Fairness in Asbestos Injury Resolution Act of 2004 (Senate
Bill 2290, the "FAIR Bill") was introduced in the United States Senate.
The FAIR Bill has not been approved by the Senate, has not been introduced
in the House of Representatives, and is not law.
The FAIR Bill introduced in the Senate is intended to establish a
nationally administered trust fund to compensate asbestos personal injury
claimants. In the FAIR Bill's current form, companies that have made past
payments for asbestos personal injury claims would be required to
contribute amounts to a national trust fund on a periodic basis that would
pay the claims of qualifying asbestos personal injury claimants. The
nationally administered trust fund would be the exclusive remedy for
asbestos personal injury claims, and such claims could not be brought in
state or federal court as long as such claims are being compensated under
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the national trust fund.
In the FAIR Bill's current form, the amounts to be paid to the national
trust fund are based on an allocation methodology set forth in the FAIR
Bill. The amounts that participants, including the Debtors, would be
required to pay are not dischargeable in a bankruptcy proceeding. The FAIR
Bill also provides, among other things, that the national trust fund shall
cease paying new claims if it is determined that the money in the fund is
not sufficient to compensate eligible claimants. In such a case, under the
terms of the current FAIR Bill, the claimants and defendants would return
to the federal court system to resolve claims not paid by the national
trust fund. The text of the FAIR Bill as introduced in the Senate may be
found at http://thomas.loc.gov (type in bill number "S.2290").
Enactment of the FAIR Bill or similar legislation addressing the financial
contributions of the Debtors for asbestos personal injury claims would
have a material impact on the amount of the Debtors' asbestos personal
injury liability and Debtors' Chapter 11 Cases.
The outcome of the legislative process, however, is inherently
speculative, and it cannot be known whether the FAIR Bill or similar
legislation will ever be enacted or, even if enacted, what the terms of
the final legislation might be. Many labor organizations, including the
AFL-CIO, as well as some Senators, have indicated that they oppose the
FAIR Bill as introduced because, among other things, they believe that the
FAIR Bill does not provide sufficient compensation to asbestos claimants.
On April 22, 2004, the Senate defeated a motion to proceed with floor
consideration of the FAIR Bill. Discussions continue regarding possible
revisions to the FAIR Bill that would allow it to move forward, but it is
unclear whether these discussions will produce agreements on key issues.
It is likely that even if the FAIR Bill is enacted, the terms of the
enacted legislation will be different from the current FAIR Bill, and
those differences may be material to the FAIR Bill's impact on the
Corporation.
During the legislative process, proceedings in the Chapter 11 Cases will
continue. See Consequences of the Filing, above, and Note 13. Litigation.
PRE-PETITION LIABILITIES OTHER THAN ASBESTOS-RELATED CLAIMS
Subsequent to the Filing, the Debtors received approval from the
Bankruptcy Court to pay or otherwise honor certain of their pre-petition
obligations, including employee wages, salaries, benefits and other
employee obligations, and from limited available funds, pre-petition
claims of certain critical vendors, real estate taxes, environmental
obligations, certain customer programs and warranty claims, and certain
other pre-petition claims.
Pursuant to the Bankruptcy Code, schedules were filed by the Debtors with
the Bankruptcy Court on October 23, 2001, and certain of the schedules
were amended on May 31, 2002, and December 13, 2002, setting forth the
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assets and liabilities of the Debtors as of the date of the Filing. The
Bankruptcy Court established a bar date of January 15, 2003, by which
proofs of claim were required to be filed against the Debtors for all
claims other than asbestos-related personal injury claims as defined in
the Bankruptcy Court's order.
Approximately 5,000 proofs of claim for general unsecured creditors
(including pre-petition debtholders and contingent claims, but excluding
asbestos-related claims), totaling approximately $8.7 billion were filed
by the bar date. Of this amount, $5.7 billion worth of claims have been
withdrawn from the case by creditors. The Debtors have been analyzing the
remaining proofs of claim and determined that many of them are duplicates
of other proofs of claim or of liabilities previously scheduled by the
Debtors. In addition, many claims were filed against multiple Debtors or
against an incorrect Debtor, or were incorrectly claiming a priority level
higher than general unsecured or an incorrect dollar amount. To date, the
court has expunged 264 claims totaling $29.5 million as duplicates;
expunged 416 claims totaling $198.4 million as amended or superceded;
allowed the reduction of 565 claims by a total of $5.5 million; and
allowed the correction of the Debtors on 1,209 claims and the
reclassification of 258 claims to general unsecured claims. The Debtors
continue to analyze and reconcile filed claims on an ongoing basis.
The deadline to bring avoidance actions in the Chapter 11 Cases was June
25, 2003. Avoidance actions could include claims to avoid alleged
preferences made during the 90-day period prior to the filing (or one-year
period for insiders) and other transfers made or obligations incurred
which could be alleged to be constructive or actual fraudulent conveyances
under applicable law. Effective prior to the avoidance action deadline,
the Bankruptcy Court granted the motion of the committee representing the
unsecured creditors to file a complaint seeking to avoid and recover as
preferences certain pre-petition payments made by the Debtors to 206
creditors, where such payments, in most cases, exceeded $500,000. The
Bankruptcy Court also granted the committee's request to extend the time
by which the summons and complaint are served upon each named defendant
until 90 days after confirmation of a plan of reorganization filed in
connection with the Chapter 11 Cases.
In addition, prior to the deadline for filing avoidance actions, certain
of the Debtors entered into a Tolling Agreement pursuant to which the
Debtors voluntarily agreed to extend the time during which actions could
be brought to avoid certain intercompany transactions that occurred during
the one-year period prior to the filing of the Chapter 11 Cases. The
transactions as to which the Tolling Agreement applies are the creation of
liens on certain assets of Debtor subsidiaries in favor of the Corporation
in connection with intercompany loan agreements; a transfer by U.S. Gypsum
to the Corporation of a 9% interest in the equity of CGC Inc., the
principal Canadian subsidiary of the Corporation; and transfers made by
the Corporation to USG Foreign Investments, Ltd., a non-Debtor subsidiary.
The Bankruptcy Court approved the Tolling Agreement in June 2003.
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The Debtors expect to address claims for general unsecured creditors
through liquidation, estimation or disallowance of the claims. In
connection with this process, the Debtors will make adjustments to their
schedules and financial statements as appropriate. Any such adjustments
could be material to the Corporation's consolidated financial position,
cash flows and results of operations in any given period. At this time, it
is not possible to estimate the Debtors' liability for these claims.
However, it is likely that the Debtors' liability for these claims will be
different from the amounts now recorded by the Debtors. Proofs of claim
alleging asbestos property damage claims are discussed in Note 13.
Litigation under Developments in the Reorganization Proceeding.
FINANCIAL STATEMENT PRESENTATION
The accompanying consolidated financial statements have been prepared in
accordance with American Institute of Certified Public Accountants
("AICPA") Statement of Position 90-7 ("SOP 90-7"), "Financial Reporting by
Entities in Reorganization Under the Bankruptcy Code," and on a
going-concern basis, which contemplates continuity of operations,
realization of assets and liquidation of liabilities in the ordinary
course of business. However, as a result of the Filing, such realization
of assets and liquidation of liabilities, without substantial adjustments
and/or changes of ownership, are subject to uncertainty. Given this
uncertainty, there is substantial doubt about the Corporation's ability to
continue as a going concern. Such doubt includes, but is not limited to, a
possible change in control of the Corporation, as well as a potential
change in the composition of the Corporation's business portfolio. The
financial statements do not include any adjustments that might result from
the outcome of this uncertainty. While operating as debtors-in-possession
under the protection of chapter 11 of the Bankruptcy Code and subject to
Bankruptcy Court approval or otherwise as permitted in the ordinary course
of business, the Debtors, or any of them, may sell or otherwise dispose of
assets and liquidate or settle liabilities for amounts other than those
reflected in the consolidated financial statements. Further, a plan of
reorganization could materially change the amounts and classifications in
the historical consolidated financial statements.
The Corporation's ability to continue as a going concern is dependent
upon, among other things, (i) the ability of the Corporation to maintain
adequate cash on hand, (ii) the ability of the Corporation to generate
cash from operations, (iii) confirmation of a plan of reorganization under
the Bankruptcy Code and (iv) the Corporation's ability to be profitable
following such confirmation. The Corporation believes that cash and
marketable securities on hand and future cash available from operations
will provide sufficient liquidity to allow its businesses to operate in
the normal course without interruption for the duration of the chapter 11
proceedings. This includes its ability to meet post-petition obligations
of the Debtors and to meet obligations of the non-Debtor subsidiaries.
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LIABILITIES SUBJECT TO COMPROMISE
As reflected in the consolidated financial statements, liabilities subject
to compromise refers to the Debtors' liabilities incurred prior to the
commencement of the Chapter 11 Cases. The amounts of the various
liabilities that are subject to compromise are set forth in the table
below. These amounts represent the Debtors' estimate of known or potential
pre-petition claims to be resolved in connection with the Chapter 11
Cases. Such claims remain subject to future adjustments. Adjustments may
result from (i) negotiations, (ii) actions of the Bankruptcy Court, (iii)
further developments with respect to disputed claims, (iv) rejection of
executory contracts and unexpired leases, (v) the determination as to the
value of any collateral securing claims, (vi) proofs of claim, including
unaccrued and unrecorded post-petition interest expense, (vii) effect of
any legislation which may be enacted or (viii) other events.
The amount shown below for the asbestos reserve reflects the Corporation's
pre-petition estimate of liability associated with asbestos claims to be
filed in the tort system through 2003, and this liability, in addition to
liability for post-2003 claims, is the subject of significant dispute in
the Chapter 11 Cases. See Note 13. Litigation for additional information
on the background of asbestos litigation, developments in the
Corporation's reorganization proceeding and estimated cost.
As of the date of this report, virtually all of the Corporation's
pre-petition debt is in default due to the Filing and included in
liabilities subject to compromise. This includes debt outstanding of $469
million under the pre-petition bank credit facilities and $536 million of
other outstanding debt.
Payment terms for liabilities subject to compromise will be established as
part of a plan of reorganization under the Chapter 11 Cases. Liabilities
subject to compromise in the consolidated and debtor-in-possession balance
sheets as of June 30 consisted of the following items (dollars in
millions):
As of As of
June 30, December 31,
2004 2003
-------- ------------
Accounts payable $ 162 $ 162
Accrued expenses 42 44
Debt 1,005 1,005
Asbestos reserve 1,061 1,061
Other long-term liabilities 13 14
-------- ------------
Subtotal 2,283 2,286
Elimination of intercompany accounts payable (43) (43)
-------- ------------
Total liabilities subject to compromise 2,240 2,243
======== ============
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INTERCOMPANY TRANSACTIONS
In the normal course of business, the Corporation (also referred to as the
"Parent Company" in the following discussion of intercompany transactions)
and the operating subsidiaries engage in intercompany transactions. To
document the relations created by these transactions, the Parent Company
and the operating subsidiaries, from the formation of the Corporation in
1985, have been parties to intercompany loan agreements that evidence
their obligations as borrowers or rights as lenders arising out of
intercompany cash transfers and various allocated intercompany charges
(the "Intercompany Corporate Transactions").
The Corporation operates a consolidated cash management system under which
the cash receipts of the domestic operating subsidiaries are ultimately
concentrated in Parent Company accounts. Cash disbursements for those
operating subsidiaries originate from those Parent Company concentration
accounts. Allocated intercompany charges from the Parent Company to the
operating subsidiaries primarily include expenses related to rent,
property taxes, information technology, and research and development,
while allocated intercompany charges between certain operating
subsidiaries primarily include expenses for shared marketing, sales,
customer service, engineering and accounting services. Detailed accounting
records are maintained of all cash flows and intercompany charges through
the system in either direction. Net balances, receivables or payables of
such cash transactions are reviewed on a regular basis with interest
earned or accrued on the balances. During the first six months of 2001,
the Corporation took steps to secure the obligations from each of the
principal domestic operating subsidiaries under the intercompany loan
agreements when it became clear that the asbestos liability claims of U.S.
Gypsum were becoming an increasingly greater burden on the Corporation's
cash resources.
As of June 30, 2004, U.S. Gypsum and USG Interiors had net pre-petition
payable balances to the Parent Company for Intercompany Corporate
Transactions of $295 million and $109 million, respectively. L&W Supply
had a net pre-petition receivable balance from the Parent Company of $33
million. These pre-petition balances are subject to the provisions of the
Tolling Agreement discussed above. See Pre-Petition Liabilities Other Than
Asbestos Personal Injury Claims, above.
As of June 30, 2004, U.S. Gypsum and L&W Supply had net post-petition
receivable balances from the Parent Company for Intercompany Corporate
Transactions of $273 million and $160 million, respectively. USG Interiors
had a net post-petition payable balance to the Parent Company of $16
million.
In addition to the above transactions, the operating subsidiaries engage
in ordinary course purchase and sale of products with other operating
subsidiaries (the "Intercompany Trade Transactions"). Detailed accounting
records also are maintained of all such transactions, and settlements are
made on a monthly basis. Certain Intercompany Trade Transactions between
-14-
U.S. and non-U.S. operating subsidiaries are settled via wire transfer
payments utilizing several payment systems.
CHAPTER 11 REORGANIZATION EXPENSES
Chapter 11 reorganization expenses in the consolidated and
debtor-in-possession statements of earnings consisted of the following
(dollars in millions):
Three Months Six Months
ended June 30, ended June 30,
-------------- --------------
2004 2003 2004 2003
---- ---- ---- ----
Legal and financial advisory fees $ 6 $ 5 $ 10 $ 9
Bankruptcy-related interest income (2) (2) (4) (4)
---- ---- ---- ----
Total chapter 11 reorganization expenses 4 3 6 5
==== ==== ==== ====
INTEREST EXPENSE
For the second quarter and first six months of 2004, contractual interest
expense not accrued or recorded on pre-petition debt totaled $18 and $35
million, respectively. From the Petition Date through June 30, 2004,
contractual interest expense not accrued or recorded on pre-petition debt
totaled $221 million. Although no post-petition accruals are required to
be made for such contractual interest expense, debtholders may seek to
recover such amounts in the Chapter 11 Cases.
DIP FINANCIAL STATEMENTS
Under the Bankruptcy Code, the Corporation is required to file
periodically with the Bankruptcy Court various documents including
financial statements of the Debtors (the Debtor-In-Possession or "DIP"
financial statements). The Corporation cautions that these financial
statements are prepared according to requirements under the Bankruptcy
Code. While these financial statements accurately provide information
required under the Bankruptcy Code, they are nonetheless unconsolidated,
unaudited and prepared in a format different from that used in the
Corporation's consolidated financial statements filed under the securities
laws. Accordingly, the Corporation believes the substance and format do
not allow meaningful comparison with the Corporation's regular publicly
disclosed consolidated financial statements. The Debtors consist of the
Corporation and the following wholly owned subsidiaries: United States
Gypsum Company; USG Interiors, Inc.; USG Interiors International, Inc.;
L&W Supply Corporation; Beadex Manufacturing, LLC; B-R Pipeline Company;
La Mirada Products Co., Inc.; Stocking Specialists, Inc.; USG Industries,
Inc.; and USG Pipeline Company.
The condensed DIP financial statements of the Debtors are presented as
follows:
-15-
USG CORPORATION AND OTHER DEBTOR COMPANIES
DEBTOR-IN-POSSESSION STATEMENT OF EARNINGS
(DOLLARS IN MILLIONS)
(UNAUDITED)
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
----------------- -------------------
2004 2003 2004 2003
------- ----- ------- -------
Net sales $ 1,035 $ 827 $ 1,953 $ 1,608
Cost of products sold 853 719 1,648 1,403
Selling and administrative expenses 67 70 132 139
Chapter 11 reorganization expenses 4 3 6 5
Interest expense 1 2 2 3
Interest income (1) (1) (1) (1)
Other (income) expense, net - (2) - (4)
------- ----- ------- -------
Earnings before income taxes and
cumulative effect of accounting
change 111 36 166 63
Income taxes 47 17 73 29
------- ----- ------- -------
Earnings before cumulative effect
of accounting change 64 19 93 34
Cumulative effect of accounting
change - - - (13)
------- ----- ------- -------
Net earnings 64 19 93 21
======= ===== ======= =======
-16-
USG CORPORATION AND OTHER DEBTOR COMPANIES
DEBTOR-IN-POSSESSION BALANCE SHEETS
(DOLLARS IN MILLIONS)
(UNAUDITED)
AS OF AS OF
JUNE 30, DECEMBER 31,
2004 2003
-------- ------------
ASSETS
Current Assets:
Cash and cash equivalents $ 444 $ 489
Short-term marketable securities 65 64
Restricted cash 26 7
Receivables (net of reserves - $11 and $11) 422 276
Inventories 309 232
Income taxes receivable 20 21
Deferred income taxes 44 41
Other current assets 46 47
-------- ------------
Total current assets 1,376 1,177
Long-term marketable securities 211 176
Property, plant and equipment (net of accumulated
depreciation and depletion - $687 and $645) 1,572 1,576
Deferred income taxes 148 178
Goodwill 41 39
Other assets 356 358
-------- ------------
Total Assets 3,704 3,504
======== ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable 241 168
Accrued expenses 184 186
Income taxes payable 26 4
-------- ------------
Total current liabilities 451 358
Other liabilities 415 403
Liabilities subject to compromise 2,240 2,243
Stockholders' Equity:
Preferred stock - -
Common stock 5 5
Treasury stock (258) (258)
Capital received in excess of par value 101 101
Accumulated other comprehensive income 13 8
Retained earnings 737 644
-------- ------------
Total stockholders' equity 598 500
-------- ------------
Total Liabilities and Stockholders' Equity 3,704 3,504
======== ============
-17-
USG CORPORATION AND OTHER DEBTOR COMPANIES
DEBTOR-IN-POSSESSION STATEMENTS OF CASH FLOWS
(DOLLARS IN MILLIONS)
(UNAUDITED)
SIX MONTHS
ENDED JUNE 30,
---------------
2004 2003
----- ----
OPERATING ACTIVITIES:
Net earnings $ 93 $ 21
Adjustments to reconcile net earnings to net cash:
Cumulative effect of accounting change - 13
Depreciation, depletion and amortization 46 44
Deferred income taxes 24 16
(Gain) loss on asset dispositions (1) -
(Increase) decrease in working capital:
Receivables (146) (70)
Income taxes receivable 1 3
Inventories (77) (10)
Payables 95 31
Accrued expenses (2) (43)
(Increase) decrease in intercompany receivable 18 (10)
(Increase) decrease in other assets (9) (3)
Increase (decrease) increase in other liabilities 12 2
Change in asbestos receivable 11 19
Decrease in liabilities subject to compromise (3) (17)
Other, net (8) (6)
----- -----
Net cash provided by (used for) operating activities 54 (10)
----- -----
INVESTING ACTIVITIES:
Capital expenditures (41) (24)
Purchases of marketable securities (171) (148)
Sale or maturities of marketable securities 135 91
Net proceeds from asset dispositions 1 -
Acquisition of business (4) (2)
----- -----
Net cash used for investing activities (80) (83)
----- -----
FINANCING ACTIVITIES:
Deposit of restricted cash (19) (21)
----- -----
Net cash used for financing activities (19) (21)
----- -----
Net decrease in cash and cash equivalents (45) (114)
Cash and cash equivalents at beginning of period 489 478
----- -----
Cash and cash equivalents at end of period 444 364
===== =====
SUPPLEMENTAL CASH FLOW DISCLOSURES:
Interest paid 1 1
Income taxes paid, net 25 1
-18-
(3) EXIT ACTIVITIES
In the fourth quarter of 2003, the Corporation recorded a charge of $3
million pretax ($2 million after-tax) for severance related to a salaried
workforce reduction of approximately 70 employees. An additional 56 open
positions were eliminated. Payments totaling $1 million were made in the
fourth quarter of 2003, and a reserve of $2 million was included in
accrued expenses on the consolidated balance sheet as of December 31,
2003. The remaining payments of $2 million were made in the first quarter
of 2004.
(4) EARNINGS PER SHARE
Basic earnings per share are based on the weighted average number of
common shares outstanding. Diluted earnings per share are based on the
weighted average number of common shares outstanding and the dilutive
effect of the potential exercise of outstanding stock options. Diluted
earnings per share exclude the potential exercise of outstanding stock
options for any period in which such exercise would have an anti-dilutive
effect. The reconciliation of basic earnings per share to diluted earnings
per share is shown in the following table (dollars in millions, except
share data):
Weighted
Average
Net Shares Per-Share
Earnings (000) Amount
-------- ------ ---------
Three Months Ended June 30,
2004:
Basic earnings $ 80 43,017 $ 1.86
Dilutive effect of stock options 1
---- ------ ---------
Diluted earnings 80 43,018 1.86
==== ====== =========
2003:
Basic earnings 31 43,046 0.73
Dilutive effect of stock options -
---- ------ ---------
Diluted earnings 31 43,046 0.73
==== ====== =========
Six Months Ended June 30,
2004:
Basic earnings $137 43,020 $ 3.18
Dilutive effect of stock options 1
---- ------ ---------
Diluted earnings 137 43,021 3.18
==== ====== =========
2003:
Basic earnings 37 43,097 0.86
Dilutive effect of stock options -
---- ------ ---------
Diluted earnings 37 43,097 0.86
==== ====== =========
-19-
(5) MARKETABLE SECURITIES
As of June 30, 2004 and 2003, the Corporation's investments in marketable
securities consisted of the following (dollars in millions):
2004 2003
------------------- ------------------
Fair Fair
Amortized Market Amortized Market
Cost Value Cost Value
--------- -------- --------- -------
Asset-backed securities $ 113 $ 112 $ 108 $ 108
U.S. government and agency securities 69 69 64 65
Municipal securities 40 40 28 28
Corporate securities 51 51 10 10
Time deposits 4 4 27 27
------- ------- ------- -------
Total marketable securities 277 276 237 238
======= ======= ======= =======
Contractual maturities of marketable securities as of June 30, 2004, were
as follows (dollars in millions):
Fair
Amortized Market
Cost Value
--------- ------
Due in 1 year or less $ 69 $ 69
Due in 1-5 years 44 44
Due in 5-10 years 5 5
Due after 10 years 46 46
--------- ------
164 164
Asset-backed securities 113 112
--------- ------
Total marketable securities 277 276
========= ======
The average duration of the portfolio is less than one year because a
majority of the longer-term securities have paydown or put features and
liquidity facilities.
The Corporation had investments in marketable securities with a fair
market value of $173 million that were in an unrealized loss position for
less than 12 months as of June 30, 2004. These investments were in the
following types of securities: $81 million in asset-backed securities, $58
million in government and agency securities, $30 million in corporate
securities and $4 million in time deposits. The unrealized losses for
these investments amounted to $1 million. The Corporation also had $3
million in asset backed securities, $3 million in government and agency
securities, and $4 million in corporate securities that had been in a
continuous loss position for a period greater than 12 months as of June
30, 2004. The amount of unrealized loss positions for these investments
was less than $100,000.
-20-
(6) ASSET RETIREMENT OBLIGATIONS
On January 1, 2003, the Corporation adopted SFAS No. 143, "Accounting for
Asset Retirement Obligations." This standard requires the recording of the
fair value of a liability for an asset retirement obligation in the period
in which it is incurred. The Corporation's asset retirement obligations
include reclamation requirements as regulated by government authorities
related principally to assets such as the Corporation's mines, quarries,
landfills, ponds and wells. The impact to the Corporation of adopting SFAS
No. 143 was an increase in assets of $14 million, which included a $12
million increase in deferred tax assets, and an increase in liabilities of
$30 million, which included a $1 million increase in deferred tax
liabilities. A noncash, after-tax charge of $16 million ($27 million
pretax) was reflected on the consolidated statement of earnings as a
cumulative effect of a change in accounting principle as of January 1,
2003. The liability for asset retirement obligations was $35 million as of
June 30, 2004, and December 31, 2003.
(7) GOODWILL AND OTHER INTANGIBLE ASSETS
Total goodwill amounted to $41 million as of June 30, 2004, and $39
million as of December 31, 2003. Goodwill increased by $2 million during
the first six months of 2004 as a result of a business acquisition during
the period.
Other intangible assets amounted to $2 million as of June 30, 2004, and
December 31, 2003. As of June 30, 2004, $1 million of this amount was
subject to amortization over a five-year life. Other intangible assets are
included in other assets on the consolidated balance sheet.
-21-
(8) DERIVATIVE INSTRUMENTS
The Corporation uses derivative instruments to manage selected commodity
price and foreign currency exposures. The Corporation does not use
derivative instruments for trading purposes. All derivative instruments
are recorded on the balance sheet at fair value. For derivatives
designated as fair value hedges, the changes in the fair values of both
the derivative instrument and the hedged item are recognized in earnings
in the current period. For derivatives designated as cash flow hedges, the
effective portion of changes in the fair value of the derivative is
recorded to accumulated other comprehensive income (loss) on the balance
sheet and is reclassified to earnings when the underlying transaction has
an impact on earnings. The ineffective portion of changes in the fair
value of the derivative is reported in cost of products sold. The amount
of ineffectiveness recorded in the second quarter and first six months of
2004 amounted to pretax income of $1 million and $2 million respectively.
COMMODITY DERIVATIVE INSTRUMENTS
The Corporation uses swap contracts to hedge anticipated purchases of
natural gas to be used in its manufacturing operations. The current
contracts, all of which mature by December 31, 2005, are generally
designated as cash flow hedges, with changes in fair value recorded to
accumulated other comprehensive income (loss) until the hedged transaction
occurs, at which time it is reclassified to earnings. As of June 30, 2004,
the fair value of these swap contracts was $25 million ($15 million
after-tax), of which $23 million ($14 million after-tax) remained in
accumulated other comprehensive income (loss).
FOREIGN EXCHANGE DERIVATIVE INSTRUMENTS
The Corporation has operations in a number of countries and uses forward
contracts from time to time to hedge selected risk of changes in cash
flows resulting from forecasted intercompany and third-party sales or
purchases denominated in non-U.S. currencies. These contracts are
generally designated as cash flow hedges, for which changes in fair value
are recorded to accumulated other comprehensive income (loss) until the
underlying transaction has an impact on earnings. As of June 30, 2004, the
Corporation had no such foreign currency contracts.
COUNTERPARTY RISK
The Corporation is exposed to credit losses in the event of nonperformance
by the counterparties on its financial instruments. All counterparties
have investment grade credit standing; accordingly, the Corporation
anticipates that these counterparties will be able to satisfy fully their
obligations under the contracts. The Corporation does not generally obtain
collateral or other security to support financial instruments subject to
credit risk but monitors the credit standing of all counterparties.
-22-
(9) COMPREHENSIVE INCOME
The components of comprehensive income are summarized in the following
table (dollars in millions):
Three Months Six Months
ended June 30, ended June 30,
-------------- --------------
2004 2003 2004 2003
----- ---- ----- ----
Net earnings $ 80 $ 31 $ 137 $ 37
----- ---- ----- ----
Pretax gain (loss) on derivatives (1) (2) 12 (2)
Income tax benefit (expense) - 1 (5) 1
----- ---- ----- ----
Gain (loss) on derivatives, net of tax (1) (1) 7 (1)
----- ---- ----- ----
Deferred currency translation (7) 13 (9) 24
----- ---- ----- ----
Unrealized gain (loss) on marketable
securities, net of tax (1) - (1) -
----- ---- ----- ----
Total comprehensive income 71 43 134 60
===== ==== ===== ====
There was no tax impact on the foreign currency translation adjustments.
The components of accumulated other comprehensive income (loss) included
on the consolidated balance sheets are summarized in the following table
(dollars in millions):
As of As of
June 30, December 31,
2004 2003
-------- ------------
Gain on derivatives, net of tax $ 17 $ 10
Deferred currency translation (17) (8)
Minimum pension liability, net of tax (3) (3)
Unrealized gain (loss) on marketable securities, net of tax (1) -
-------- ------------
Total accumulated other comprehensive income (loss) (4) (1)
======== ============
During the second quarter of 2004, accumulated net after-tax gains of $5
million ($9 million pretax) on derivatives were reclassified from
accumulated other comprehensive income (loss) to earnings. As of June 30,
2004, the estimated net after-tax gain expected to be reclassified within
the next 12 months from accumulated other comprehensive income (loss) into
earnings is $15 million.
-23-
(10) EMPLOYEE RETIREMENT PLANS
The components of net pension and postretirement benefits costs for the
three months and six months ended June 30, 2004 and 2003 are summarized in
the following table (dollars in millions):
Three Months Six Months
ended June 30, ended June 30,
-------------- --------------
2004 2003 2004 2003
----- ---- ----- ----
PENSION:
Service cost of benefits earned $ 9 $ 9 $ 16 $ 14
Interest cost on projected
benefit obligation 14 13 27 26
Expected return on plan assets (14) (13) (27) (26)
Net amortization 4 3 9 6
----- ---- ----- ----
Net cost 13 12 25 20
===== ==== ===== ====
POSTRETIREMENT:
Service cost of benefits earned 3 3 7 6
Interest cost on projected
benefit obligation 6 6 11 11
Recognized loss 2 - 2 -
----- ---- ----- ----
Net cost 11 9 20 17
===== ==== ===== ====
In accordance with the Corporation's funding policy, the Corporation and
its subsidiaries contributed cash of $30 million and $38 million during
the second quarter and first six months of 2004, respectively, and expect
to contribute cash of approximately $74 million during the full year 2004
to their pension plans.
On May 19, 2004, the Financial Accounting Standards Board ("FASB") issued
FASB Staff Position ("FSP") FAS 106-2, "Accounting and Disclosure
Requirements Related to the Medicare Prescription Drug, Improvement and
Modernization Act of 2003." FSP 106-2 provides guidance on accounting for
the effects of prescription drug provisions of the Medicare Act (the
"Act") for employers that sponsor postretirement health care plans that
provide prescription drug benefits and requires those employers to provide
certain disclosures regarding the effect of the federal subsidy provided
by the Act. This FSP supercedes FSP 106-1 of the same subject that allowed
employers to either defer or recognize the legislation's effect. The new
disclosure requirements will be effective for the first financial
reporting period that begins after June 15, 2004. The Corporation adopted
FSP 106-2 effective July 1, 2004 and estimates that the adoption of this
FSP will result in an approximate $40 million reduction in its accumulated
postretirement benefit obligation and a related $3 million reduction in
net periodic postretirement benefit cost during the last six months of
2004 versus the cost previously anticipated.
-24-
In addition, the required remeasurement of the plan's liability assumed a
change in the health-care-cost trend rate which resulted in increases in
the accumulated postretirement benefit obligation and net periodic
postretirement benefit cost. These increases largely offset the reduction
in the liability and costs related to the adoption of FSP 106-2 as
described above.
(11) STOCK-BASED COMPENSATION
The Corporation accounts for stock-based compensation using the intrinsic
value method, which measures compensation cost as the quoted market price
of the stock at the date of grant less the grant price, if any, that the
employee is required to pay. If the Corporation had elected to recognize
compensation cost for stock-based compensation grants using the fair value
method, net earnings and net earnings per common share would not have
changed as shown below (dollars in millions, except per-share data):
Three Months Six Months
ended June 30, ended June 30,
-------------- --------------
2004 2003 2004 2003
----- ----- ----- -----
NET EARNINGS:
Net Earnings: As reported $ 80 $ 31 $ 137 $ 37
Deduct: Fair value method of stock
-based employee compensation
expense, net of tax - - - -
----- ----- ----- -----
Pro forma net earnings 80 31 137 37
===== ===== ===== =====
BASIC AND DILUTED EARNINGS PER SHARE:
As reported 1.86 0.73 3.18 0.86
Pro forma 1.86 0.73 3.18 0.86
===== ===== ===== =====
Subsequent to the Filing, no stock option grants have been issued.
As of June 30, 2004, common shares totaling 2,346,500 were reserved for
future issuance in conjunction with existing stock option grants. In
addition, 2,549,720 common shares were reserved for future grants. Shares
issued in option exercises may be from original issue or available
treasury shares.
-25-
(12) OPERATING SEGMENTS
The Corporation's operations are organized into three operating segments:
(i) North American Gypsum, which manufactures SHEETROCK(R) brand gypsum
wallboard and joint compound, DUROCK(R) brand cement board, FIBEROCK(R)
brand gypsum fiber panels and other related building products in the
United States, Canada and Mexico; (ii) Worldwide Ceilings, which
manufactures ceiling tile in the United States and ceiling grid in the
United States, Canada, Europe and the Asia-Pacific region; and (iii)
Building Products Distribution, which distributes gypsum wallboard,
drywall metal, ceiling products, joint compound and other building
products throughout the United States. Operating segment results were as
follows (dollars in millions):
Three Months Six Months
ended June 30, ended June 30,
----------------- -------------------
2004 2003 2004 2003
------- ----- ------- -------
NET SALES:
North American Gypsum $ 678 $ 566 $ 1,317 $ 1,108
Worldwide Ceilings 190 154 356 301
Building Products Distribution 454 325 816 620
Eliminations (177) (131) (324) (253)
------- ----- ------- -------
Total USG Corporation 1,145 914 2,165 1,776
======= ===== ======= =======
OPERATING PROFIT:
North American Gypsum 102 47 183 85
Worldwide Ceilings 26 9 41 17
Building Products Distribution 31 16 45 24
Corporate (20) (18) (36) (36)
Chapter 11 reorganization expenses (4) (3) (6) (5)
Eliminations (2) (1) (2) -
------- ----- ------- -------
Total USG Corporation 133 50 225 85
======= ===== ======= =======
(13) LITIGATION
ASBESTOS AND RELATED BANKRUPTCY LITIGATION
One of the Corporation's subsidiaries, U.S. Gypsum, is among many
defendants in more than 100,000 asbestos lawsuits alleging personal injury
or property damage liability. Most of the asbestos lawsuits against U.S.
Gypsum seek compensatory and, in many cases, punitive damages for personal
injury allegedly resulting from exposure to asbestos-containing products
(the "Personal Injury Cases"). Certain of the asbestos lawsuits seek to
recover compensatory and, in many cases, punitive damages for costs
associated with the maintenance or removal and replacement of
asbestos-containing products in buildings (the "Property Damage Cases"). A
more detailed description of the Property Damage and Personal Injury Cases
against U.S. Gypsum and asbestos personal injury cases against certain
other Debtors is set forth below.
U.S. Gypsum's asbestos liability derives from its sale of certain
asbestos-
-26-
containing products beginning in the late 1920s. In most cases, the
products were discontinued or asbestos was removed from the formula by
1972, and no asbestos-containing products were produced after 1978.
The amount of U.S. Gypsum's present and future asbestos liabilities is the
subject of significant dispute in Debtors' Chapter 11 Cases. If the amount
of the Debtors' asbestos liabilities is not resolved through negotiation
in the Chapter 11 Cases or addressed by federal legislation, the amount of
those liabilities may be determined through litigation proceedings in the
Chapter 11 Cases, the outcome of which is extremely speculative.
Recent developments in the Corporation's bankruptcy proceeding and a more
detailed discussion of the Debtors' asbestos liabilities are addressed
below. See also Note 2. Voluntary Reorganization Under Chapter 11, above,
for additional information on the voluntary reorganization proceeding and
potential federal legislation.
DEVELOPMENTS IN THE REORGANIZATION PROCEEDING: In late 2001, the Debtors'
Chapter 11 Cases, along with four other asbestos-related bankruptcies,
were assigned to Judge Alfred M. Wolin of the United States District Court
for the District of New Jersey.
In 2002, the Debtors filed a motion requesting Judge Wolin to conduct
hearings to substantively estimate the Debtors' liability for asbestos
personal injury claims. The Debtors requested that the Court hear evidence
and make rulings regarding the characteristics of valid asbestos personal
injury claims against the Debtors and then estimate the Debtors' liability
for present and future asbestos personal injury claims based upon these
rulings. One of the key liability issues is whether claimants who do not
have objective evidence of asbestos-related disease have valid claims and
are entitled to be compensated by the Debtors or whether such claimants
are entitled to compensation only if and when they develop
asbestos-related disease.
The Official Committee of Asbestos Personal Injury Claimants opposed the
substantive estimation hearings proposed by the Debtors. The committee
contends that U.S. Gypsum's liability for present and future asbestos
personal injury claims should be based on extrapolation from U.S. Gypsum's
settlement history of such claims and not on litigating liability issues
in the bankruptcy proceeding. The committee contends that the Bankruptcy
Court does not have the power to exclude claimants who do not have
objective evidence of asbestos-related disease if such claimants are
compensated in the tort system outside of bankruptcy.
The Debtors also filed a motion with Judge Wolin requesting a ruling that
putative claimants who cannot satisfy objective standards of
asbestos-related disease are not entitled to vote on a Section 524(g)
plan. The Debtors' motion on this voting issue has been stayed by order of
Judge Wolin. It is
-27-
expected that the Official Committee of Asbestos Personal Injury Claimants
will oppose the Debtors' motion.
In response to the Debtors' motion seeking substantive estimation of the
Debtors' asbestos personal injury liability, Judge Wolin issued a
Memorandum Opinion and Order (the "Order") on February 19, 2003, setting
forth a procedure for estimating the Debtors' liability for present and
future asbestos personal injury claims alleging cancer. The Order provides
that the Court will set a bar date for the filing of asbestos personal
injury claims alleging cancer and that the Court will hold an estimation
hearing regarding these claims under 11 U.S.C. Section 502(c), at which
the "debtors will be permitted to present their defenses."
The Order contemplates that after the estimation of the Debtors' liability
for present and future cancer claims, the Court will determine whether the
Debtors' liability for these cancer claims alone exceeds the Debtors'
assets. According to the Order, the determination of whether the Debtors
have sufficient assets to pay legitimate cancer claimants will guide the
Court in determining whether the Debtors' resources should be spent
resolving the issue of the validity of non-malignant claims where there is
no objective evidence of asbestos-related disease.
No timetable has been set for implementation of the Order or any hearing
on estimation of the Debtors' liability for cancer claims.
In November 2003, the Debtors and the committee representing unsecured
creditors in the Chapter 11 Cases filed a motion to recuse, or remove,
Judge Wolin from presiding over these cases. The motion stated that Judge
Wolin should remove himself from presiding over these cases because he has
appointed and relied upon advisors to assist him in resolution of these
cases who have conflicts of interest and he has had multiple private
communications between or among certain parties to these cases, the
advisors, and other unidentified persons, without all parties being
present and having knowledge of these communications.
On May 17, 2004, the Third Circuit Court of Appeals issued an opinion and
order directing Judge Wolin to remove himself from presiding over Debtors'
Chapter 11 Cases. The court of appeals also directed that the Debtors'
Chapter 11 Cases be reassigned to another district court judge. Effective
June 30, 2004, Judge Wolin resigned from his position as district court
judge. The Debtor's Chapter 11 Cases have not yet been reassigned to a new
district court judge.
In the second quarter of 2004, Judge Judith K. Fitzgerald, the bankruptcy
judge presiding over the Debtors' Chapter 11 Cases, entered an order
directing the parties to enter into non-binding mediation relating to the
Debtors' asbestos personal injury liability and the potential terms of a
plan of reorganization. Judge Fitzgerald appointed David Geronemus as
mediator. It
-28-
is expected that the mediation will begin in the third quarter of 2004.
The Debtors were recently informed by the mediator that the legal
representative for future asbestos claimants has raised the issue of
whether USG Corporation and its subsidiaries may be liable for asbestos
personal injury claims arising from the sale of asbestos-containing
products by A.P. Green Refractories Co. ("A.P. Green") before 1967. A.P.
Green, which manufactured and sold products used in refractories, was
acquired by merger into U.S. Gypsum Company in 1967 and thereafter
operated as a wholly-owned subsidiary of U.S. Gypsum Company until 1985,
at which time A.P. Green became a wholly-owned subsidiary of USG
Corporation. In 1988, A.P. Green became a publicly-traded company when its
shares were distributed to the shareholders of USG Corporation. In
February 2002, A.P. Green (now known as A.P. Green Industries, Inc.), as
well as its parent company, Global Industrial Technologies, Inc., and
other affiliates, filed voluntary petitions for reorganization through
which A.P. Green and its affiliates seek to resolve their asbestos-related
liabilities. The A.P. Green reorganization proceeding is pending in the
United States Bankruptcy Court for the Western District of Pennsylvania
and is captioned In re: Global Industrial Technologies, Inc. (Case No.
02-21626). The Corporation does not have sufficient information at this
time to predict whether or how any plan of reorganization in the Debtors'
Chapter 11 Cases might address any asbestos-related liability based on
sales of asbestos-containing products by A.P. Green.
The legal representative for future asbestos claimants and the Official
Committee of Asbestos Personal Injury Claimants have also recently raised
the issue of whether the assets and liabilities of all Debtors should be
temporarily consolidated for purposes of the treatment of claims under a
plan of reorganization. Under this theory, which is sometimes called
"substantive consolidation," the liabilities of all Debtors subject to
this consolidation, including liabilities based on sales of
asbestos-containing products by U.S. Gypsum, would be paid from the pooled
assets of U.S. Gypsum and all other Debtors subject to consolidation. If
applied, substantive consolidation could materially and adversely affect
the recovery rights of creditors of Debtors other than U.S. Gypsum and the
holders of the Corporation's equity.
As a result of the removal of Judge Wolin from Debtors' Chapter 11 Cases
and the commencement of mediation, the Corporation does not know whether
estimation proceedings regarding the Debtors' liability for cancer claims,
as contemplated by Judge Wolin's February 19, 2003 Order, will occur. The
Corporation also does not know whether the Court will ultimately address
the validity and voting rights of non-malignant claims where there is no
objective evidence of asbestos-related disease.
With regard to asbestos property damage claims, the Bankruptcy Court
established a bar date requiring all such claims against the Debtors to be
filed by January 15, 2003. The Debtors continue to analyze and review the
asbestos-related property damage claims received as of the claims bar
date.
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Approximately 1,400 asbestos property damage claims were filed,
representing more than 2,000 buildings. In contrast, as of the Petition
Date, 11 Property Damage Cases were pending against U.S. Gypsum.
Approximately 500 of the asbestos property damage claims filed by the bar
date assert a specific dollar amount of damages, and the total damages
alleged in those claims is approximately $1.6 billion. However, this
amount reflects numerous duplicate claims filed against multiple Debtors.
Approximately 900 claims do not specify a damage amount. Most of the
asbestos property damage claims filed do not provide any evidence that the
Debtors' products were ever installed in any of the buildings at issue.
Certain of the proof of claim forms purport to file claims on behalf of
two classes of claimants that were the subject of pre-petition class
actions. One of these claim forms was filed on behalf of a class of
colleges and universities that was certified for certain purposes in a
pre-petition lawsuit filed in federal court in South Carolina. However,
many of the putative members of this class also filed individual claim
forms. Four of the claim forms were filed by a claimant allegedly on
behalf of putative members of certified and uncertified classes in
connection with a pre-petition lawsuit pending in South Carolina state
court.
The Debtors believe that they have substantial defenses to many of these
property damage claims, including the lack of evidence that the Debtors'
products were ever installed in the buildings at issue, the failure to
file the claims within the applicable statutes of limitation, and the lack
of evidence that the claimants have any damages. The Debtors intend to
address many of these claims through an objection and disallowance process
in the Bankruptcy Court. The Debtors have begun this process by issuing
written notices to claimants that failed to provide evidence that any of
the Debtors' products were ever installed in the buildings at issue. To
date, the Debtors have issued these deficiency notices with regard to more
than 1,200 buildings and expect to issue additional notices. Because of
the preliminary nature of the objection process, the Corporation cannot
predict the outcome of these proceedings or the impact the proceedings may
have on the estimated cost of resolving asbestos property damage claims.
See Estimated Cost, below.
The following is a summary of the Personal Injury and Property Damage
Cases pending against U.S. Gypsum and certain other Debtors as of the
Petition Date.
PERSONAL INJURY CASES: As reported by the Center for Claims Resolution
(the "Center"), U.S. Gypsum was a defendant in more than 100,000 pending
Personal Injury Cases as of the Petition Date, as well as an additional
approximately 52,000 Personal Injury Cases that may be the subject of
settlement agreements. In the first half of 2001, up to the Petition Date,
approximately 26,200 new Personal Injury Cases were filed against U.S.
Gypsum, as reported by the Center, as compared to 27,800 new filings in
the first half of 2000. Prior to the Filing, U.S. Gypsum managed the
handling and settlement of Personal Injury Cases through its membership in
the Center. From 1988 up to February 1, 2001, the Center administered and
arranged for the defense and
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settlement of Personal Injury Cases against U.S. Gypsum and other Center
members. During that period, costs of defense and settlement of Personal
Injury Cases were shared among the members of the Center pursuant to
predetermined sharing formula. Effective February 1, 2001, the Center
members, including U.S. Gypsum, ended their prior settlement-sharing
arrangement. Up until the Petition Date, the Center continued to
administer and arrange for the defense and settlement of the Personal
Injury Cases, but liability payments were not shared among the Center
members.
In 2000 and years prior, U.S. Gypsum and other Center members negotiated a
number of settlements with plaintiffs' law firms that included agreements
to resolve over time the firms' pending Personal Injury Cases as well as
certain future claims (the "Long-Term Settlements"). With regard to future
claims, these Long-Term Settlements typically provide that the plaintiffs'
firms will recommend to their future clients that they defer filing, or
accept nominal payments on, personal injury claims that do not meet
established disease criteria and, with regard to those claims meeting
established disease criteria, that the future clients agree to settle
those claims for specified amounts. These Long-Term Settlements typically
resolve claims for amounts consistent with historical per-claim settlement
costs paid to the plaintiffs' firms involved. As a result of the Filing,
cash payments by U.S. Gypsum under these Long-Term Settlements have
ceased, and U.S. Gypsum expects that its obligations under these
settlements will be determined in the bankruptcy proceeding and plan of
reorganization.
In 2000, U.S. Gypsum closed approximately 57,000 Personal Injury Cases.
U.S. Gypsum's cash payments in 2000 to defend and resolve Personal Injury
Cases totaled $162 million, of which $90 million was paid or reimbursed by
insurance. In 2000, the average settlement per case was approximately
$2,600, exclusive of defense costs. U.S. Gypsum made cash payments of $100
million in 1999 and $61 million in 1998 to resolve Personal Injury Cases,
of which $85 million and $45.5 million, respectively, were paid or
reimbursed by insurance.
During late 2000 and in 2001, following the bankruptcy filings of other
defendants in asbestos personal injury litigation, plaintiffs
substantially increased their settlement demands to U.S. Gypsum. In
response to these increased settlement demands, U.S. Gypsum attempted to
manage its asbestos liability by contesting, rather than settling, a
greater number of cases that it believed to be non-meritorious. As a
result, in the first and second quarters of 2001, U.S. Gypsum agreed to
settle fewer Personal Injury Cases, but at a significantly higher cost per
case.
In the first half of 2001, up to the Petition Date, U.S. Gypsum closed
approximately 18,900 Personal Injury Cases. In the first half of 2001, up
to the Petition Date, U.S. Gypsum's total asbestos-related cash payments,
including defense costs, were approximately $124 million, of which
approximately $10 million was paid or reimbursed by insurance. A portion
of
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these payments were for settlements agreed to in prior periods. As of
March 31, 2001, U.S. Gypsum had estimated that cash expenditures for
Personal Injury Cases in 2001 would total approximately $275 million
before insurance recoveries of approximately $37 million.
In addition to the Personal Injury Cases pending against U.S. Gypsum, one
of the Corporation's subsidiaries and a Debtor in the bankruptcy
proceeding, L&W Supply, was named as a defendant in approximately 21
pending Personal Injury Cases as of the Petition Date. L&W Supply, a
distributor of building products manufactured by U.S. Gypsum and other
building products manufacturers, has not made any payments in the past to
resolve Personal Injury Cases. Because of, among other things, the small
number of Personal Injury Cases against L&W Supply to date and the lack of
development of the cases against L&W Supply, the Corporation does not have
sufficient information at this time to predict how any plan of
reorganization will address any asbestos-related liability of L&W Supply.
One of U.S. Gypsum's subsidiaries and a Debtor in the bankruptcy
proceeding, Beadex Manufacturing, LLC ("Beadex"), manufactured and sold
joint compound containing asbestos from 1963 through 1978 in the
northwestern United States. As of the Petition Date, Beadex was a named
defendant in approximately 40 Personal Injury Cases pending primarily in
the states of Washington and Oregon. Beadex has approximately $11 million
in primary or umbrella insurance coverage available to pay
asbestos-related costs, as well as $15 million in available excess
coverage. The Corporation expects that any asbestos-related liability of
Beadex will be addressed in the plan of reorganization. However, because
of, among other things, the small number of Personal Injury Cases pending
against Beadex to date, the Corporation does not have sufficient
information at this time to predict how any plan of reorganization will
address any asbestos-related liability of Beadex.
PROPERTY DAMAGE CASES: As of the Petition Date, U.S. Gypsum was a
defendant in 11 Property Damage Cases, most of which involved multiple
buildings. One of the cases is a conditionally certified class action
comprising all colleges and universities in the United States, which
certification is presently limited to the resolution of certain allegedly
"common" liability issues (Central Wesleyan College v. W.R. Grace & Co.,
et al., U.S.D.C. S.C.). As a result of the Filing, all Property Damage
Cases are stayed against U.S. Gypsum. U.S. Gypsum's estimated cost of
resolving the Property Damage Cases is discussed in Estimated Cost, below.
INSURANCE COVERAGE: As of June 30, 2004, all prior receivables relating to
insurance remaining to cover asbestos-related costs had been collected by
U.S. Gypsum. This insurance receivable had been included in other current
assets on the consolidated balance sheet.
ESTIMATED COST: In evaluating U.S. Gypsum's estimated asbestos liability
prior to the Filing, the Corporation considered numerous uncertainties
that
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made it difficult to estimate reliably U.S. Gypsum's asbestos liability in
the tort system for both pending and future asbestos claims.
In the Property Damage Cases, such uncertainties included, but were not
limited to, the identification and volume of asbestos-containing products
in the buildings at issue in each case, which is often disputed; the
claimed damages; the viability of statute of limitations and other
defenses; the amount for which such cases can be resolved, which normally
(but not uniformly) has been substantially lower than the claimed damages;
and the viability of claims for punitive and other forms of multiple
damages.
Uncertainties in the Personal Injury Cases included, but were not limited
to, the number, disease, age, and occupational characteristics of
claimants in the Personal Injury Cases; the jurisdiction and venue in
which such cases were filed; the viability of claims for conspiracy or
punitive damages; the elimination of indemnity sharing among Center
members for future settlements and its negative impact on U.S. Gypsum's
ability to continue to resolve claims at historical or acceptable levels;
the adverse impact on U.S. Gypsum's settlement costs of recent
bankruptcies of co-defendants; the possibility of additional bankruptcies
of other defendants; the possibility of significant adverse verdicts due
to recent changes in settlement strategies and related effects on
liquidity; the inability or refusal of former Center members to fund their
share of existing settlements and its effect on such settlement
agreements; the continued ability to negotiate settlements or develop
other mechanisms that defer or reduce claims from unimpaired claimants;
and the possibility that federal legislation addressing asbestos
litigation would be enacted. The Corporation reported that adverse
developments with respect to any of these uncertainties could have a
material impact on U.S. Gypsum's settlement costs and could materially
increase the cost above the estimated range discussed below.
In 2000, an independent actuarial study of U.S. Gypsum's current and
potential future asbestos liabilities was completed. This analysis was
based on the assumption that U.S. Gypsum's asbestos liability would
continue to be resolved in the tort system.
As part of this analysis, the Corporation and its independent consultant
reviewed, among other things, the factors listed above as well as
epidemiological data concerning the incidence of past and projected future
asbestos-related diseases; trends in the propensity of persons alleging
asbestos-related disease to sue U.S. Gypsum; the adverse effect on
settlement costs of historical reductions in the number of solvent
defendants available to pay claims, including reductions in membership of
the Center; the pre-agreed settlement recommendations in, and the
viability of, the Long-Term Settlements; anticipated trends in recruitment
by plaintiffs' law firms of non-malignant or unimpaired claimants; future
defense costs; and allegations that U.S. Gypsum and the other Center
members bear joint liability for the share of certain settlement
agreements that was to be paid by former members
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that now have refused or are unable to pay. The study attempted to weigh
relevant variables and assess the impact of likely outcomes on future case
filings and settlement costs.
Based upon the results of the actuarial study, the Corporation determined
that, although substantial uncertainty remained, it was probable that
asbestos claims pending against U.S. Gypsum and future asbestos claims to
be filed against it through 2003 (both property damage and personal
injury) could be resolved in the tort system for an amount between $889
million and $1,281 million, including defense costs, and that within this
range the most likely estimate was $1,185 million. Consistent with this
analysis, in the fourth quarter of 2000, the Corporation recorded a pretax
noncash charge of $850 million to results of operations, which, combined
with the previously existing reserve, increased U.S. Gypsum's reserve for
asbestos claims to $1,185 million. These amounts are stated before tax
benefit and are not discounted to present value. Less than 10% of the
reserve was attributable to defense and administrative costs.
At the time of recording this reserve, it was expected that the reserve
amounts would be expended over a period extending several years beyond
2003, because asbestos cases in the tort system historically have been
resolved an average of three years after filing. The Corporation concluded
that it did not have adequate information to allow it to reasonably
estimate the number of claims to be filed after 2003, or the liability
associated with such claims.
The Corporation believes that, as a result of the Filing and activities
relating to potential federal legislation addressing asbestos personal
injury claims, there is greater uncertainty in estimating the reasonably
possible range of asbestos liability for pending and future claims as well
as the most likely estimate of liability within this range. There are
significant differences in the treatment of asbestos claims in a
bankruptcy proceeding as compared to the tort litigation system. Among
other things, these uncertainties include: (i) how the Long-Term
Settlements will be treated in the bankruptcy proceeding and plan of
reorganization and whether those settlements will be set aside; (ii) the
number of asbestos claims that will be filed or addressed in the
proceeding; (iii) the number of future claims that will be estimated in
connection with preparing a plan of reorganization; (iv) how claims for
punitive damages and claims by persons with no objective evidence of
asbestos-related disease will be treated and whether such claims will be
allowed or compensated; (v) the impact historical settlement values for
asbestos claims may have on the estimation of asbestos liability in the
bankruptcy proceeding; (vi) the results of any litigation proceedings in
the Chapter 11 Cases regarding the estimated value of present and future
asbestos personal injury claims alleging cancer or other diseases; (vii)
the treatment of asbestos property damage claims in the bankruptcy
proceeding; and (viii) the impact any relevant potential federal
legislation may have on the proceeding. See Note 2. Voluntary
Reorganization Under Chapter 11 - Potential
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Federal Legislation Regarding Asbestos Personal Injury Claims. These
factors, as well as the uncertainties discussed above in connection with
the resolution of asbestos cases in the tort system, increase the
uncertainty of any estimate of asbestos liability.
As a result, it is the Corporation's view that no change should be made at
this time to the previously recorded reserve for asbestos claims, except
to reflect certain minor asbestos-related costs incurred since the Filing.
The reserve as of June 30, 2004, which was determined based on claims
expected to be filed against U.S. Gypsum through 2003, was $1,061 million.
As the Chapter 11 Cases and legislation process proceed, the Debtors
likely will gain more information from which a reasonable estimate of the
Debtors' probable liability for present and future asbestos claims can be
determined. If such estimate differs from the existing reserve, the
reserve will be adjusted, and it is possible that a charge to results of
operations will be necessary at that time. In such a case, the Debtors'
asbestos liability could vary significantly from the recorded estimate of
liability and could be greater than the high end of the range estimated in
2000. This difference could be material to the Corporation's financial
position, cash flows and results of operations in the period recorded.
BOND TO SECURE CERTAIN CENTER OBLIGATIONS: In January 2001, U.S. Gypsum
obtained a performance bond from Safeco Insurance Company of America
("Safeco") in the amount of $60.3 million to secure certain obligations of
U.S. Gypsum for extended payout settlements of Personal Injury Cases and
other obligations owed by U.S. Gypsum to the Center. The bond is secured
by an irrevocable letter of credit obtained by the Corporation in the
amount of $60.3 million and issued by JPMorgan Chase Bank (formerly Chase
Manhattan Bank) ("JPMorgan Chase") to Safeco. After the Filing, by a
letter dated November 16, 2001, the Center made a demand to Safeco for
payment of $15.7 million under the bond, and, by a letter dated December
28, 2001, the Center made a demand to Safeco for payment of approximately
$127 million under the bond. The amounts for which the Center made demand
were for the payment of, among other things, settlements of Personal
Injury Cases that were entered into pre-petition. The total amount
demanded by the Center under the bond, approximately $143 million, exceeds
the original penal sum of the bond, which is $60.3 million. Safeco has not
made any payment under the bond.
On November 30, 2001, the Corporation and U.S. Gypsum filed an Adversary
Complaint in the Chapter 11 Cases to, among other things, enjoin the
Center from drawing on the bond and enjoin Safeco from paying on the bond
during the pendency of these bankruptcy proceedings. This Adversary
Proceeding is pending in the United States Bankruptcy Court for the
District of Delaware and is captioned USG Corporation and United States
Gypsum Company v. Center for Claims Resolution, Inc. and Safeco Insurance
Company of America, No. 01-08932. Judge Wolin consolidated the Adversary
Proceeding with similar adversary proceedings brought by Federal-Mogul
Corp., et al., and Armstrong World Industries, Inc., et al., in their
bankruptcy proceedings.
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The parties filed cross-motions for summary judgment in the consolidated
proceedings. On March 28, 2003, in response to the cross-motions for
summary judgment, Judge Wolin issued an order and memorandum opinion which
granted in part and denied in part the Center's motion for summary
judgment. Although the court ruled that Safeco is not required to remit
any surety bond proceeds to the Center at this time, the court stated that
certain settlements that were completed before U.S. Gypsum's Petition Date
likely are covered by the surety bond but that the bond does not cover
settlement payments that were not yet completed as of the Petition Date.
The court did not rule on whether the bond covers other disputed
obligations and reserved these issues to a subsequent phase of the
litigation. As a result of the court's decision, it is likely that, absent
a settlement of this matter, some portion of the bond may be drawn but
that the amount drawn may be substantially less than the full amount of
the bond. To the extent that Safeco were to pay all or any portion of the
bond, it is likely that Safeco would draw down the JPMorgan Chase letter
of credit to cover the bond payment and JPMorgan Chase would assert a
pre-petition claim in a corresponding amount against the Corporation in
the bankruptcy proceeding.
In light of the Third Circuit Court of Appeals order dated May 17, 2004,
removing Judge Wolin from Debtors' Chapter 11 Cases, it is expected that
the CCR bond litigation will be addressed by the district court judge
ultimately assigned to the Debtors' Chapter 11 Cases.
CONCLUSION: There are many uncertainties associated with the resolution of
the asbestos liability in the bankruptcy proceeding. The Corporation will
continue to review its asbestos liability as the Chapter 11 Cases progress
and as issues relating to the estimation of the Debtors' asbestos
liabilities are addressed. If such review results in the Debtors' estimate
of the probable liability for present and future asbestos claims being
different from the existing reserve, the reserve will be adjusted, and
such adjustment could be material to the Corporation's financial position,
cash flows and results of operations in the period recorded.
ENVIRONMENTAL LITIGATION
The Corporation and certain of its subsidiaries have been notified by
state and federal environmental protection agencies of possible
involvement as one of numerous "potentially responsible parties" in a
number of so-called "Superfund" sites in the United States. In most of
these sites, the involvement of the Corporation or its subsidiaries is
expected to be minimal. The Corporation believes that appropriate reserves
have been established for its potential liability in connection with all
Superfund sites but is continuing to review its accruals as additional
information becomes available. Such reserves take into account all known
or estimated undiscounted costs associated with these sites, including
site investigations and feasibility costs, site cleanup and remediation,
legal costs, and fines and penalties, if any. In addition, environmental
costs connected with site cleanups on Corporation-owned property also are
covered by reserves
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established in accordance with the foregoing. The Debtors have been given
permission by the Bankruptcy Court to satisfy environmental obligations up
to $12 million. The Corporation believes that neither these matters nor
any other known governmental proceeding regarding environmental matters
will have a material adverse effect upon its financial position, cash
flows or results of operations.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
OVERVIEW
USG Corporation (the "Corporation") and 10 of its United States subsidiaries
(collectively, the "Debtors") are currently operating under chapter 11 of the
United States Bankruptcy Code (the "Bankruptcy Code"), an action taken to
resolve asbestos claims in a fair and equitable manner, to protect the long-term
value of the Debtors' businesses, and to maintain the Debtors' leadership
positions in their markets. To properly understand the Corporation and its
businesses, investors, creditors or other readers of this report should first
understand the nature of this voluntary reorganization process under chapter 11
and the potential impacts the reorganization may have on their rights and
interests in the Corporation as described in more detail below. At this point,
there is great uncertainty as to the amount of the Debtors' asbestos-related
liability and thus the value of any recovery for pre-petition creditors or
stockholders under any final plan of reorganization. No plan of reorganization
has thus far been proposed.
The Corporation had $973 million of cash, cash equivalents, restricted cash and
marketable securities as of June 30, 2004, and management believes that this
liquidity plus expected operating cash flows will meet the Corporation's cash
needs, including making regular capital investments to maintain and enhance its
businesses throughout the chapter 11 proceedings.
Net sales for the second quarter of 2004 were a record level for any quarter in
the Corporation's history and represented a 25% increase from the same period in
2003. Demand for products sold by the Corporation's North American Gypsum and
Building Products Distribution operating segments was strong in the second
quarter 2004 due to strength in the new housing and repair and remodel markets.
Shipments of gypsum wallboard were at record levels for the Corporation and the
industry in the second quarter and are expected to continue at relatively high
levels throughout the remainder of 2004. The strong level of activity in the
aforementioned markets and industry utilization rates in excess of 90% in the
second quarter have resulted in a rise of market selling prices for gypsum
wallboard. U.S. Gypsum's nationwide average realized selling price for
SHEETROCK(R) brand gypsum wallboard was up 18% versus the second quarter of
2003. The Corporation's Worldwide Ceilings operating segment also reported
increased second quarter sales as compared with the same period in 2003
primarily due to a surge in sales of ceiling grid in 2004 and the implementation
of new sales and distribution policies. Some grid customers increased purchases
in anticipation of reduced supply and higher grid prices associated with a
global shortage of steel and the related rise in the cost of steel.
The Corporation's gross margin was 18.9% in the second quarter of 2004, up from
14.7% in the second quarter of 2003. Gross margin improved as a result of
increased shipments and higher selling prices for most major product lines.
However, costs related to natural gas, employee benefits (pension and medical
insurance for active employees and retirees), steel used in the manufacture of
ceiling grid, and
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wastepaper used in the manufacture of gypsum wallboard continued to rise in the
second quarter and are expected to partially offset price improvement gains in
2004.
VOLUNTARY REORGANIZATION UNDER CHAPTER 11
On June 25, 2001 (the "Petition Date"), the Debtors filed voluntary petitions
for reorganization (the "Filing") under the Bankruptcy Code. These bankruptcy
cases (the "Chapter 11 Cases") are pending in the United States Bankruptcy Court
for the District of Delaware (the "Bankruptcy Court"). The Debtors intend to
address their liability for all present and future asbestos claims, as well as
all other pre-petition claims, in a plan or plans of reorganization approved by
the Bankruptcy Court. The Debtors currently have the exclusive right to file a
plan of reorganization until December 1, 2004. The Debtors may seek one or more
additional extensions of the exclusivity period depending upon developments in
the Chapter 11 Cases.
A key factor in determining the recovery of pre-petition creditors or
stockholders under any plan of reorganization is the amount that must be
provided in the plan to resolve the Debtors' liability for present and future
asbestos claims. At this time, there is substantial uncertainty as to the amount
that will be required to resolve these asbestos claims and thus whether or to
what extent there will be any recovery for pre-petition creditors or
stockholders under any plan of reorganization.
Our Annual Report on Form 10-K, filed February 24, 2004, discusses the
background and principal impacts of the Filing as well as potential federal
legislation regarding asbestos personal injury claims. During 2004, there have
been developments regarding potential federal legislation. On April 7, 2004, the
Fairness in Asbestos Injury Resolution Act of 2004 (Senate Bill 2290, the "FAIR
Bill") was introduced in the United States Senate. The FAIR Bill has not been
approved by the Senate, has not been introduced in the House of Representatives,
and is not law.
The FAIR Bill introduced in the Senate is intended to establish a nationally
administered trust fund to compensate asbestos personal injury claimants. In the
FAIR Bill's current form, companies that have made past payments for asbestos
personal injury claims would be required to contribute amounts to a national
trust fund on a periodic basis that would pay the claims of qualifying asbestos
personal injury claimants. The nationally administered trust fund would be the
exclusive remedy for asbestos personal injury claims, and such claims could not
be brought in state or federal court as long as such claims are being
compensated under the national trust fund.
In the FAIR Bill's current form, the amounts to be paid to the national fund are
based on an allocation methodology set forth in the FAIR Bill. The amounts that
participants, including the Debtors, would be required to pay are not
dischargeable in a bankruptcy proceeding. The FAIR Bill also provides, among
other things, that
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the national trust fund shall cease paying new claims if it is determined that
the money in the trust fund is not sufficient to compensate eligible claimants.
In such a case, under the terms of the current FAIR Bill, the claimants and
defendants would return to the federal court system to resolve claims not paid
by the national trust fund. The text of the FAIR Bill as introduced in the
Senate may be found at http://thomas.loc.gov (type in bill number "S. 2290").
Enactment of the FAIR Bill or similar legislation addressing the financial
contributions of the Debtors for asbestos personal injury claims would have a
material impact on the amount of the Debtor's asbestos personal injury liability
and Debtors' Chapter 11 Cases.
The outcome of the legislative process, however, is inherently speculative, and
it cannot be known whether the FAIR Bill or similar legislation will ever be
enacted or, even if enacted, what the terms of the final legislation might be.
Many labor organizations, including the AFL-CIO, as well as some Senators, have
indicated that they oppose the FAIR Bill as introduced because, among other
things, they believe that the FAIR Bill does not provide sufficient compensation
to asbestos claimants. On April 22, 2004, the Senate defeated a motion to
proceed with floor consideration of the FAIR Bill. Discussions continue
regarding possible revisions to the FAIR Bill that would allow it to move
forward, but it is unclear whether these discussions will produce agreements on
key issues. It is likely that even if the FAIR Bill is enacted, the terms of the
enacted legislation will be different from the current FAIR Bill, and those
differences may be material to the FAIR Bill's impact on the Corporation.
During the legislative process, proceedings in the Debtors' Chapter 11 Cases
have continued. On May 17, 2004, the Third Circuit Court of Appeals ordered that
Judge Alfred M. Wolin be removed from presiding over the Debtors' Chapter 11
Cases, and, effective June 30, 2004, Judge Wolin resigned as a district court
judge. The Debtors' Chapter 11 Cases have not yet been reassigned to a new
district court judge.
In the second quarter of 2004, Judge Judith K. Fitzgerald, the bankruptcy judge
presiding over the Debtors' Chapter 11 Cases, entered an order directing the
parties to enter into non-binding mediation relating to the Debtors' asbestos
personal injury liability and the potential terms of a plan of reorganization.
Judge Fitzgerald appointed David Geronemus as mediator. It is expected that the
mediation will begin in the third quarter of 2004.
The Debtors were recently informed by the mediator that the legal representative
for future asbestos claimants has raised the issue of whether USG Corporation
and its subsidiaries may be liable for asbestos personal injury claims arising
from the sale of asbestos-containing products by A.P. Green Refractories Co.
("A.P. Green") before 1967. A.P. Green, which manufactured and sold products
used in refractories, was acquired by merger into U.S. Gypsum Company in 1967
and thereafter operated as a wholly-owned subsidiary of U.S. Gypsum Company
until 1985, at which time A.P. Green became a wholly-owned subsidiary of USG
Corporation. In 1988, A.P. Green
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became a publicly-traded company when its shares were distributed to the
shareholders of USG Corporation. In February 2002, A.P. Green (now known as A.P.
Green Industries, Inc.), as well as its parent company, Global Industrial
Technologies, Inc., and other affiliates, filed voluntary petitions for
reorganization through which A.P. Green and its affiliates seek to resolve their
asbestos-related liabilities. The A.P. Green reorganization proceeding is
pending in the United States Bankruptcy Court for the Western District of
Pennsylvania and is captioned In re: Global Industrial Technologies, Inc. (Case
No. 02-21626). The Corporation does not have sufficient information at this time
to predict whether or how any plan of reorganization in the Debtors' Chapter 11
Cases might address any asbestos-related liability based on sales of
asbestos-containing products by A.P. Green.
The legal representative for future asbestos claimants and the Official
Committee of Asbestos Personal Injury Claimants have also recently raised the
issue of whether the assets and liabilities of all Debtors should be temporarily
consolidated for purposes of the treatment of claims under a plan of
reorganization. Under this theory, which is sometimes called "substantive
consolidation," the liabilities of all Debtors subject to this consolidation,
including liabilities based on sales of asbestos-containing products by U.S.
Gypsum, would be paid from the pooled assets of U.S. Gypsum and all other
Debtors subject to consolidation. If applied, substantive consolidation could
materially and adversely affect the recovery rights of creditors of Debtors
other than U.S. Gypsum and the holders of the Corporation's equity.
See Item 1, Note 13. Litigation, for additional information on the background of
asbestos litigation, developments in the Corporation's reorganization
proceeding, and estimated cost.
ACCOUNTING IMPACT
The Corporation is required to follow American Institute of Certified Public
Accountants ("AICPA") Statement of Position 90-7 ("SOP 90-7"), "Financial
Reporting by Entities in Reorganization under the Bankruptcy Code." Pursuant to
SOP 90-7, the Corporation's pre-petition liabilities that are subject to
compromise are reported separately on the consolidated balance sheet. Virtually
all of the Corporation's pre-petition debt is currently in default and was
recorded at face value and classified within liabilities subject to compromise.
U.S. Gypsum's asbestos liability also is classified within liabilities subject
to compromise. See Item 1. Note 2. Voluntary Reorganization Under Chapter 11,
which includes information related to financial statement presentation, the
debtor-in-possession statements and detail of liabilities subject to compromise
and chapter 11 reorganization expenses.
CONSOLIDATED RESULTS OF OPERATIONS
NET SALES
Net sales in the second quarter of 2004 totaled $1,145 million, a record for any
quarter in the Corporation's history and a 25% increase from $914 million in the
-41-
second quarter of 2004 totaled $1,145 million, a record for any quarter in the
Corporation's history and a 25% increase from $914 million in the second quarter
of 2003. For the first six months of 2004, net sales totaled $2,165 million, up
22% from $1,776 million in the comparable 2003 period. Net sales are up for all
three of the Corporation's operating segments in 2004 primarily due to increased
shipments and higher selling prices for most major product lines. See Core
Business Results of Operations below for an explanation of product line results
by segment.
COST OF PRODUCTS SOLD
Cost of products sold in the second quarter of 2004 was $929 million, up 19%
from $780 million a year ago. For the first six months of 2004, cost of products
sold totaled $1,778 million, up 17% from $1,525 million in the comparable 2003
period. Key factors for these variations were increased product volume and
higher costs related to natural gas, employee benefits (pension and medical
insurance for active employees and retirees), steel used in the manufacture of
ceiling grid, and wastepaper used in the manufacture of gypsum wallboard.
GROSS PROFIT
Gross profit (net sales less cost of products sold) in the second quarter of
2004 was $216 million, a 61% increase from $134 million in the second quarter of
2003. For the first six months of 2004, gross profit totaled $387 million, up
54% from $251 million in the comparable 2003 period. Gross margin (gross profit
as a percent of net sales) was 18.9% in the second quarter of 2004, up from
14.7% in the second quarter of 2003. For the first six months of 2004, gross
margin was 17.9%, up from 14.1% in the comparable 2003 period.
SELLING AND ADMINISTRATIVE EXPENSES
Selling and administrative expenses in the second quarter of 2004 were $79
million (6.9% of net sales), down 2% from $81 million (8.9% of net sales) in the
second quarter of 2003. For the first six months, these expenses were $156
million (7.2% of net sales), versus $161 million (9.1% of net sales) a year ago.
These reductions primarily reflected a lower accrual related to the Bankruptcy
Court-approved key employee retention plan, the impact of a fourth quarter 2003
salaried workforce reduction program and other cost-reduction initiatives that
have resulted in lower overall expenses. These favorable factors were offset in
part by higher employee benefit costs (pension and medical insurance for active
employees and retirees).
CHAPTER 11 REORGANIZATION EXPENSES
Chapter 11 reorganization expenses in the consolidated and debtor-in-possession
statements of earnings consisted of the following (dollars in millions):
Three Months Six Months
ended June 30, ended June 30,
------------------------ ------------------------
2004 2003 2004 2003
------ ------ ------ ------
Legal and financial advisory fees $ 6 $ 5 $ 10 $ 9
Bankruptcy-related interest income (2) (2) (4) (4)
------ ------ ------ ------
Total chapter 11 reorganization expenses 4 3 6 5
====== ====== ====== ======
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OPERATING PROFIT
Operating profit in the second quarter of 2004 was $133 million compared with
$50 million in the second quarter of 2003. Operating profit for the first six
months of 2004 was $225 million compared with $85 million for the first six
months of 2003.
INTEREST EXPENSE
Interest expense of $1 million and $2 million was incurred in the second quarter
and first six months of 2004, respectively. Interest expense for the respective
2003 periods was $2 million and $3 million. Under SOP 90-7, virtually all of the
Corporation's outstanding debt is classified as liabilities subject to
compromise, and interest expense on this debt has not been accrued or recorded
since the Petition Date. For the second quarter and first six months of 2004,
contractual interest expense not accrued or recorded on pre-petition debt
totaled $18 million and $35 million, respectively. From the Petition Date
through June 30, 2004, contractual interest expense not accrued or recorded on
pre-petition debt totaled $221 million. Although no post-petition accruals are
required to be made for such contractual interest expense, debtholders may seek
to recover such amounts in the Chapter 11 Cases.
INTEREST INCOME
Non-bankruptcy related interest income was $1 million in the second quarter and
$2 million in the first six months of 2004, unchanged from the respective 2003
periods.
INCOME TAXES
Income tax expense amounted to $52 million and $85 million in the second quarter
and first six months of 2004, respectively, compared with $23 million and $36
million in the corresponding 2003 periods. The effective tax rates were 38.4%
and 39.9% for the first six months of 2004 and 2003, respectively. The decrease
in the effective tax rate was primarily due to a reduction in the Corporation's
tax reserves resulting from the application of recently finalized IRS
regulations to the Chapter 11 reorganization expenses incurred by the
Corporation through 2003 and the impact on the effective tax rate of a similar
amount of permanent differences but a higher amount of pretax earnings in the
first six months of 2004 versus the prior-year period.
CUMULATIVE EFFECT OF ACCOUNTING CHANGE
On January 1, 2003, the Corporation adopted Statement of Financial Accounting
Standards ("SFAS") No. 143, "Accounting for Asset Retirement Obligations." A
non-cash, after-tax charge of $16 million ($27 million pretax) was reflected on
the consolidated statement of earnings as a cumulative effect of a change in
accounting principle as of January 1, 2003. See Item 1. Note 6. Asset Retirement
Obligations for additional information related to the adoption of SFAS No. 143.
NET EARNINGS
Net earnings of $80 million, or $1.86 per share, were reported for the second
quarter of 2004 compared with $31 million, or $0.73 per share, for the second
-43-
quarter of 2003. For the first six months of 2004, net earnings totaled $137
million, or $3.18 per share, compared with $37 million, or $0.86 per share, for
the first six months of 2003.
CORE BUSINESS RESULTS OF OPERATIONS
(dollars in millions)
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
------------------------- -------------------------
2004 2003 2004 2003
------- ------- ------- -------
NET SALES:
NORTH AMERICAN GYPSUM:
U.S. Gypsum Company $ 617 $ 512 $ 1,191 $ 1,008
CGC Inc. (gypsum) 68 62 141 119
Other subsidiaries* 44 35 80 63
Eliminations (51) (43) (95) (82)
------- ------- ------- -------
Total 678 566 1,317 1,108
------- ------- ------- -------
WORLDWIDE CEILINGS:
USG Interiors, Inc. 135 114 255 224
USG International 54 42 100 82
CGC Inc. (ceilings) 15 12 28 22
Eliminations (14) (14) (27) (27)
------- ------- ------- -------
Total 190 154 356 301
------- ------- ------- -------
BUILDING PRODUCTS DISTRIBUTION:
L&W Supply Corporation 454 325 816 620
------- ------- ------- -------
Eliminations (177) (131) (324) (253)
------- ------- ------- -------
Total USG Corporation 1,145 914 2,165 1,776
======= ======= ======= =======
OPERATING PROFIT:
NORTH AMERICAN GYPSUM:
U.S. Gypsum Company 87 36 148 66
CGC Inc. (gypsum) 9 7 22 12
Other subsidiaries* 6 4 13 7
------- ------- ------- -------
Total 102 47 183 85
------- ------- ------- -------
WORLDWIDE CEILINGS:
USG Interiors, Inc. 19 7 31 13
USG International 4 1 5 2
CGC Inc. (ceilings) 3 1 5 2
------- ------- ------- -------
Total 26 9 41 17
------- ------- ------- -------
BUILDING PRODUCTS DISTRIBUTION:
L&W Supply Corporation 31 16 45 24
------- ------- ------- -------
Corporate (20) (18) (36) (36)
Chapter 11 reorganization expenses (4) (3) (6) (5)
Eliminations (2) (1) (2) -
------- ------- ------- -------
Total USG Corporation 133 50 225 85
======= ======= ======= =======
*Includes USG Mexico, S.A. de C.V., a building products business in Mexico,
Gypsum Transportation Limited, a shipping company in Bermuda, and USG Canadian
Mining Ltd., a mining operation in Nova Scotia.
-44-
NORTH AMERICAN GYPSUM
Net sales of $678 million increased 20% from the second quarter of 2003, while
operating profit more than doubled to $102 million. First six months net sales
of $1,317 million reflected an increase of 19% from a year ago, while operating
profit of $183 million increased 115%.
For the second quarter of 2004, net sales for U.S. Gypsum increased $105
million, or 21%, compared with the second quarter of 2003, while operating
profit rose $51 million, or 142%. These increases primarily reflected record
shipments of SHEETROCK(R) brand gypsum wallboard and joint compound, DUROCK(R)
brand cement board and FIBEROCK(R) brand gypsum fiber panels and increased
selling prices for SHEETROCK(R) brand gypsum wallboard.
U.S. Gypsum sold 2.8 billion square feet of SHEETROCK(R) brand gypsum wallboard
during the second quarter of 2004, a record for any quarter and an 8% increase
from 2.6 billion square feet sold in the second quarter of 2003. U.S. Gypsum's
wallboard plants operated at 95% of capacity in the second quarter of 2004
compared with 90% in the second quarter of 2003. Industry shipments of gypsum
wallboard were up approximately 12% from the second quarter of 2003.
U.S. Gypsum's nationwide average realized selling price for SHEETROCK(R) brand
gypsum wallboard was $118.47 per thousand square feet in the second quarter of
2004. This price was up 18% from $100.47 in the second quarter of 2003 and up 7%
from $110.33 in the first quarter of 2004.
The improved pricing and record shipments for gypsum wallboard more than offset
the unfavorable effects of higher costs for wastepaper (the primary raw material
of wallboard paper), natural gas (a major source of energy for the company) and
employee benefits. However, improved production efficiencies at the company's
gypsum wallboard plants offset a portion of the cost increase.
Net sales for the gypsum business of Canada-based CGC Inc. increased $6 million
or 10% and operating profit rose $2 million, or 29%, as compared with the second
quarter of 2003. These results were primarily attributable to higher shipments
of SHEETROCK(R) brand gypsum wallboard partially offset by slightly lower
wallboard and joint compound selling prices.
WORLDWIDE CEILINGS
Second quarter 2004 net sales of $190 million increased 23%, while operating
profit nearly tripled to $26 million as compared with the second quarter of
2003. For the first six months of 2004, net sales of $356 million were up 18%,
while operating profit increased to $41 million from $17 million a year ago.
USG Interiors, Inc., the Corporation's domestic ceilings business, reported a
$21 million, or 18%, increase in net sales compared with the second quarter of
2003, while operating profit increased to $19 million from $7 million. Increased
volume and higher selling prices for ceiling grid largely reflected a surge in
demand for ceiling grid in 2004 due to customer concerns over reduced supply and
higher grid
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prices associated with a global shortage of steel and the related rise in the
cost of steel. The cost of steel used in the manufacture of ceiling grid rose
significantly during the first half of 2004. The Corporation expects that due to
current demand for steel, the cost of steel will continue to rise during the
second half of 2004 but at a lesser rate than for the first half of the year.
The favorable grid results, as well as higher selling prices for ceiling tile,
also were positively impacted by the company's new sales and distribution
policies.
USG International's second quarter 2004 net sales improved 29% and operating
profit rose to $4 million from $1 million versus the second quarter of 2003
primarily due to increased demand for ceiling grid in Europe.
The ceilings business of CGC Inc. reported a $3 million increase in net sales
and a $2 million increase in operating profit for the second quarter of 2004.
BUILDING PRODUCTS DISTRIBUTION
L&W Supply Corporation ("L&W Supply"), the leading specialty building products
distribution business in the United States, reported second quarter net sales of
$454 million and operating profit of $31 million, representing increases of 40%
and 94% respectively, from the second quarter of 2003. For the first six months
of 2004, net sales of $816 million and operating profit of $45 million increased
32% and 88%, respectively, versus the first six months of 2003. These increases
reflected record shipments and improved pricing of gypsum wallboard and
complementary building products, such as drywall metal, ceiling products, joint
compound and roofing. Second quarter 2004 shipments of L&W Supply's gypsum
wallboard were up 12% versus the same prior year period, while selling prices
increased 14%.
L&W Supply operated 184 locations in the United States as of June 30, 2004,
compared with 183 locations as of June 30, 2003.
MARKET CONDITIONS AND OUTLOOK
The gypsum industry experienced a record level of wallboard shipments in the
second quarter of 2004 attributable to continued strength in the new housing and
the residential remodeling markets. The robust level of activity in these
markets, which together account for nearly two-thirds of all demand for gypsum
wallboard, and utilization rates in excess of 90% for the industry, have
resulted in a rise of market selling prices for gypsum wallboard.
The outlook for the balance of the year remains favorable. The strength of the
residential market is expected to continue, although the exceptional strength of
the first half of the year may abate in the second half. Increasing mortgage
rates may affect the level of demand in both the new housing and residential
remodeling markets. The commercial construction market, the principal market for
the Corporation's ceilings products, is showing signs of improvement, but office
vacancy rates remain at very high levels.
-46-
In addition, the Corporation, like many other companies, faces many ongoing cost
pressures such as higher prices for natural gas and raw materials and increased
employee benefits.
The Corporation continues to focus its management attention and investments on
improving customer service, manufacturing costs and operating efficiencies, as
well as selectively investing to grow its businesses. In addition, the
Corporation will diligently continue its attempt to resolve the chapter 11
proceedings, consistent with the goal of achieving a fair, comprehensive and
final resolution to its asbestos liability.
LIQUIDITY AND CAPITAL RESOURCES
LIQUIDITY
As of June 30, 2004, the Corporation had $973 million of cash, cash equivalents,
restricted cash and marketable securities, of which $227 million of cash and
cash equivalents was held by non-Debtor subsidiaries. The total amount of $973
million was up $26 million, or 3%, from $947 million as of December 31, 2003.
Since the Petition Date, the Corporation's level of liquidity has increased due
to strong operating cash flows and the absence of cash payments related to
asbestos settlements and principal and interest on pre-petition debt.
Contractual interest expense not accrued or recorded on pre-petition debt was
$35 million in the first six months of 2004 and $221 million since the Petition
Date.
CASH FLOWS
As shown on the consolidated statement of cash flows, cash and cash equivalents
decreased $36 million during the first six months of 2004. The primary source of
cash in the first half of 2004 was earnings from operations. Primary uses of
cash were: (i) working capital of $151 million (largely customer rebates,
employee incentive compensation and other seasonal needs), (ii) net purchases of
marketable securities of $36 million, (iii) capital spending of $47 million,
(iv) the designation of $26 million as restricted cash representing cash
collateral primarily to support outstanding letters of credit issued mainly for
purchases of steel from foreign suppliers and (v) the use of $4 million for an
acquisition.
Net cash from operating activities was $71 million during the first six months
of 2004 compared with $4 million used for operating activities during the same
period in 2003. This variation was primarily attributable to the increase in
2004 earnings from operations. Net cash used for investing activities decreased
to $81 million from $95 million primarily due to lower net purchases of
marketable securities in 2004. Net cash used for financing activities of $26
million (the designation of restricted cash as described above) during the first
half of 2004 represented a $5 million increase versus the first half of 2003.
WORKING CAPITAL
Total working capital (current assets less current liabilities) as of June 30,
2004, amounted to $1,226 million, and the ratio of current assets to current
-47-
liabilities was 3.43-to-1. As of December 31, 2003, working capital amounted to
$1,084 million, and the ratio of current assets to current liabilities was
3.62-to-1.
Receivables increased to $488 million as of June 30, 2004, from $321 million as
of December 31, 2003, primarily reflecting a 37% increase in net sales for the
month of June 2004 as compared with December 2003. Inventories and payables also
were up from December 31, 2003, primarily due to the increased level of
business. Inventories increased to $357 million from $280 million, and accounts
payable increased to $274 million from $202 million. Accrued expenses declined
slightly to $203 million from $206 million as of December 31, 2003.
MARKETABLE SECURITIES
As of June 30, 2004, $276 million was invested in marketable securities, up $36
million from $240 million as of December 31, 2003. Of the June 30, 2004 amount,
$211 million was invested in long-term marketable securities and $65 million in
short-term marketable securities. The Corporation's marketable securities are
classified as available-for-sale securities and reported at fair market value
with unrealized gains and losses excluded from earnings and reported in
accumulated other comprehensive income (loss) on the consolidated balance sheet.
CAPITAL EXPENDITURES
Capital spending amounted to $47 million in the first six months of 2004,
compared with $36 million in 2003. As of June 30, 2004, remaining capital
expenditure commitments for the replacement, modernization and expansion of
operations amounted to $128 million, compared with $95 million as of December
31, 2003.
During the bankruptcy proceeding, the Corporation expects to have limited
ability to access capital other than its own cash, marketable securities and
future cash flows to fund potential future growth opportunities such as new
products, acquisitions and joint ventures. Nonetheless, the Corporation expects
to be able to pursue a program of capital spending aimed at maintaining and
enhancing its businesses.
RESTRICTED CASH AND LETTERS OF CREDIT
The Corporation has a $100 million credit agreement, which expires April 30,
2006, with LaSalle Bank N.A. (the "LaSalle Facility") to be used exclusively to
support the issuance of letters of credit needed to support business operations.
As of June 30, 2004, $25 million of letters of credit, which are cash
collateralized at 103%, were outstanding.
The Corporation has posted additional cash collateral in the amount of $7
million to support outstanding letters of credit and a bank guarantee issued by
Commerzbank in Germany.
As of June 30, 2004, a total of $33 million was reported as restricted cash on
the consolidated balance sheet.
-48-
DEBT
As of June 30, 2004, total debt amounted to $1,007 million, of which $1,005
million was included in liabilities subject to compromise. These amounts were
unchanged from the December 31, 2003, levels and do not include any accruals for
post-petition contractual interest expense.
EXIT ACTIVITIES
In the fourth quarter of 2003, the Corporation recorded a charge of $3 million
pretax ($2 million after-tax) for severance related to a salaried workforce
reduction of approximately 70 employees. An additional 56 open positions were
eliminated. Payments totaling $1 million were made in the fourth quarter of
2003, and a reserve of $2 million was included in accrued expenses on the
consolidated balance sheet as of December 31, 2003. The remaining payments of $2
million were made in the first quarter of 2004.
LEGAL CONTINGENCIES
As a result of the Filing, all pending asbestos lawsuits against the Debtors are
stayed, and no party may take any action to pursue or collect on such asbestos
claims absent specific authorization of the Bankruptcy Court. See Item 1. Note
13. Litigation for additional information on the background of asbestos
litigation, developments in the Corporation's reorganization proceeding and
estimated cost.
The Corporation and certain of its subsidiaries have been notified by state and
federal environmental protection agencies of possible involvement as one of
numerous "potentially responsible parties" in a number of so-called "Superfund"
sites in the United States. The Corporation believes that neither these matters
nor any other known governmental proceeding regarding environmental matters will
have a material adverse effect upon its financial position, cash flows or
results of operations. See Item 1. Note 13. Litigation for additional
information on environmental litigation.
CRITICAL ACCOUNTING POLICIES
The preparation of the Corporation's financial statements requires management to
make estimates, judgments and assumptions that affect the reported amounts of
assets, liabilities, revenues and expenses during the periods presented. The
Corporation's 2003 Annual Report on Form 10-K, which was filed on February 24,
2004, includes a summary of the critical accounting policies the Corporation
believes are the most important to aid in understanding its financial results.
There have been no material changes to these critical accounting policies that
impacted the Corporation's reported amounts of assets, liabilities, revenues or
expenses during the first half of 2004.
-49-
FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements related to management's
expectations about future conditions. The effects of the Filing and the conduct,
outcome and costs of the Chapter 11 Cases, as well as the ultimate costs
associated with the Corporation's asbestos litigation, including the possible
impact of any asbestos-related legislation, may differ from management's
expectations. Actual business or other conditions may also differ from
management's expectations and accordingly affect the Corporation's sales and
profitability or other results. Actual results may differ due to various other
factors, including economic conditions such as the levels of construction
activity, employment levels, interest rates, currency exchange rates and
consumer confidence; competitive conditions such as price and product
competition; shortages in raw materials; increases in raw materials and energy
costs; and the unpredictable effects of acts of terrorism or war upon domestic
and international economies and financial markets. The Corporation assumes no
obligation to update any forward-looking information contained in this report.
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures.
The Corporation's chief executive officer and chief financial officer, after
evaluating the effectiveness of the Corporation's "disclosure controls and
procedures" (as defined in Rule 13a-15(e) of the Securities Exchange Act of
1934), have concluded that, as of the end of the fiscal quarter covered by this
report on Form 10-Q, the Corporation's disclosure controls and procedures were
adequate and designed to ensure that material information relating to the
Corporation and its consolidated subsidiaries would be made known to them by
others within those entities.
(b) Changes in internal control over financial reporting.
There was no change in the Corporation's "internal control over financial
reporting" (as defined in Rule 13a-15(f) of the Securities Exchange Act of 1934)
identified in connection with the evaluation required by Rule 13a-15(d) of the
Securities Exchange Act of 1934 that occurred during the fiscal quarter covered
by this report on Form 10-Q that has materially affected, or is reasonably
likely to materially affect, the Corporation's internal control over financial
reporting.
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders and Board of Directors of USG Corporation:
We have reviewed the accompanying consolidated balance sheets of USG Corporation
and subsidiaries as of June 30, 2004 and the related consolidated statements of
earnings for the three month and six month periods ended June 30, 2004 and 2003
and the consolidated statements of cash flows for the six month periods ended
June 30, 2004 and 2003. These interim financial statements are the
responsibility of the Corporation's management.
We conducted our reviews in accordance with standards of the Public Company
Accounting Oversight Board (United States). A review of interim financial
information consists principally of applying analytical procedures and making
inquiries of persons responsible for financial and accounting matters. It is
substantially less in scope than an audit conducted in accordance with standards
of the Public Company Accounting Oversight Board (United States), the objective
of which is the expression of an opinion regarding the financial statements
taken as a whole. Accordingly, we do not express such an opinion.
Based on our reviews, we are not aware of any material modifications that should
be made to the accompanying consolidated interim financial statements for them
to be in conformity with accounting principles generally accepted in the United
States of America.
We have previously audited, in accordance with standards of the Public Company
Accounting Oversight Board (United States), the consolidated balance sheets of
USG Corporation and subsidiaries as of December 31, 2003 and 2002, and the
related consolidated statements of earnings, stockholders' equity, and cash
flows for each of the two years then ended (not presented herein); and in our
report dated February 10, 2004 we expressed an unqualified opinion on those
consolidated financial statements and included explanatory paragraphs concerning
(i) matters which raise substantial doubt about the Corporation's ability to
continue as a going concern; (ii) changes in methods of accounting for asset
retirement obligations and goodwill and other intangible assets due to the
Corporation's adoption of Statement of Financial Accounting Standards (SFAS) No.
143, "Accounting for Asset Retirement Obligations" in 2003, and SFAS No. 142,
"Goodwill and Other Intangible Assets" in 2002; and (iii) the application of
procedures relating to certain disclosures of financial statement amounts
related to the 2001 financial statements that were audited by other auditors who
have ceased operations and for which we have expressed no opinion or other form
of assurance other than with respect to such disclosures. In our opinion, the
information set forth in the accompanying condensed consolidated balance sheet
as of December 31, 2003 is fairly stated, in all material respects, in relation
to the consolidated balance sheet from which it has been derived.
-51-
As discussed in Note 2 to the consolidated financial statements, USG Corporation
and certain subsidiaries voluntarily filed for Chapter 11 bankruptcy protection
on June 25, 2001. The accompanying consolidated financial statements do not
purport to reflect or provide for the consequences of the bankruptcy
proceedings. In particular, such financial statements do not purport to show (a)
as to assets, their realizable value on a liquidation basis or their
availability to satisfy liabilities; (b) as to pre-petition liabilities, the
amounts that may be allowed for claims or contingencies, or the status and
priority thereof; (c) as to stockholder accounts, the effect of any changes that
may be made in the capitalization of the Corporation; or (d) as to operations,
the effect of any changes that may be made in its business.
The accompanying consolidated financial statements have been prepared assuming
that the Corporation will continue as a going concern. As discussed in Notes 2
and 13 to the consolidated financial statements, there is significant
uncertainty as to the resolution of the Corporation's asbestos litigation,
which, among other things, may lead to possible changes in the composition of
the Corporation's business portfolio, as well as changes in the ownership of the
Corporation. This uncertainty raises substantial doubt about the Corporation's
ability to continue as a going concern. Management's plans in regard to these
matters are also described in Notes 2 and 13 to the financial statements. The
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
/s/ DELOITTE & TOUCHE LLP
DELOITTE & TOUCHE LLP
Chicago, Illinois
July 28, 2004
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See Part I, Item 1. Note 13. Litigation for information concerning the asbestos
and related bankruptcy litigation and environmental litigation.
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND/OR ISSUER PURCHASES OF EQUITY
SECURITIES
(c) Total Number of (c) Maximum Number (or
Shares (or Units) Approximate Dollar Value)
(a) Total Number of (b) Average Price Purchased as Part of of Shares (or Units)
of Shares (or Units) Paid per Share (or Publicly Announced that May Yet Be Purchased
Period Purchased Unit) Plans or Programs Under the Plans or Programs
- ----------------- -------------------- ------------------ -------------------- ---------------------------
2004
January 21,877 $ 16.58 - -
February 10,643 18.85 - -
March - - - -
------------ -------- --- ---
Total 1st Quarter 32,520 17.72 - -
------------ -------- --- ---
April - - - -
May - - - -
June 1,973 15.45 - -
------------ -------- --- ---
Total 2nd Quarter 1,973 15.45 - -
------------ -------- --- ---
(a) Reflects shares reacquired to provide for tax withholdings on shares
issued to employees under the terms of the USG Corporation 1995 Long-Term
Equity Plan, 1997 Management Incentive Plan or 2000 Omnibus Management
Incentive Plan.
(b) The price per share is based upon the mean of the high and the low prices
for a USG Corporation common share on the NYSE on the date of the tax
withholding transaction.
(c) The Corporation currently does not have in place a share repurchase plan
or program.
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) In accordance with the Corporation's notice and proxy statement
dated April 1, 2004, the matters set forth in paragraphs (b) and (c)
below were submitted to a vote of stockholders at its May 12, 2004
annual meeting of stockholders.
(b) The three director-nominees (Lawrence M. Crutcher, William C. Foote
and Judith A. Sprieser) were each re-elected to a three-year term of
office which will expire in 2007. The directors whose terms of
office continued after the annual meeting of stockholders were:
Robert L. Barnett, Keith A. Brown, James C. Cotting, W. Douglas
Ford, David W. Fox, Valerie B. Jarrett, Marvin E. Lesser and John B.
Schwemm.
Votes Abstentions
Votes Withheld and Broker
For or Against Non-Votes
---------- ---------- -----------
Election of Directors:
Lawrence M. Crutcher 39,694,196 341,418 -
William C. Foote 39,703,838 331,776 -
Judith A. Sprieser 39,698,849 336,765 -
(c) The following proposal was recommended by the Corporation's Board of
Directors and was approved by a majority of the shares voted.
Votes Abstentions
Votes Withheld and Broker
For or Against Non-Votes
---------- ---------- -----------
Ratification of Appointment of
Deloitte & Touche LLP as Independent
Public Accountants 39,760,275 192,418 82,921
-54-
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
3(ii) Amended and Restated By-Laws of USG Corporation, dated May 12, 2004.
10. Key Employee Retention Plan (July 1, 2004 - December 31, 2005),
dated July 1, 2004.
15. Letter from Deloitte & Touche LLP regarding unaudited financial
information.
31.1 Rule 13a - 14(a) Certifications of USG Corporation's Chief Executive
Officer
31.2 Rule 13a - 14(a) Certifications of USG Corporation's Chief Financial
Officer
32.1 Section 1350 Certifications of USG Corporation's Chief Executive
Officer
32.2 Section 1350 Certifications of USG Corporation's Chief Financial
Officer
(b) Reports on Form 8-K:
On April 28, 2004, the Corporation furnished to the SEC a Form 8-K for the
purpose of disclosing, under "Item 12. Results of Operations and Financial
Condition," its press release containing earnings release information for
its first quarter of 2004.
On May 18, 2004, the Corporation filed with the SEC a Form 8-K for the
purpose of disclosing, under "Item 5. Other Events," that it had amended
its bylaws.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
USG CORPORATION
By /s/ William C. Foote
-----------------------------------
William C. Foote,
Chairman, Chief Executive Officer
and President
By /s/ Richard H. Fleming
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Richard H. Fleming,
Executive Vice President and
Chief Financial Officer
By /s/ D. Rick Lowes
-----------------------------------
D. Rick Lowes,
Vice President and Controller
July 30, 2004
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